What is Cost of production? Cost of production may be defined as what it takes in terms of human and material resources in producing a commodity. For goods and services to be produced, all the four factors of production of land, labout, capital and entrepreneur have to be combined. The various costs incurred in the use of these factors of production in the production of goods and services are generally called cost of production.
BASIC COST CONCEPTS
- Fixed Costs: These are the costs of resources which do not vary with the level of output in the short-run. That is, they do not change with the changing outputs I.e, no matter the quantity of products produced with the product range l, they remain the same. Examples are the costs of machinery, land and salaries of some top echelon of workers. It is calculated as FC=TC- or TFC=AFC×Quantity produced.
- Variable Costs: These are the costs of resources which vary with the level of output both in the short and long run. That is, they change with quantity of goods and services produced; the more that are produced, the higher they will be and vice versa. Examples are, the cost of raw materials, labour, etc, which rise as the level of output increcosts
- Total costs: This consists of all the amount of what it takes to produce any commodity. Total costs of a firm is arrived at by adding the fixed and variable costs. TC = FC + VC. Or TC = ATC×Q
- Average Cost: This is the cost per unit of output I.e, the cost of a commodity out of all the products produced by a firm. Average cost is arrived at by dividing the total cost by the total number of output. The average cost can also be called average total cost (ATC). ATC or AC=TC÷TQ = AFC+AVC.
- Average Variable Cost: This refers to cost per unit of variable cost of output. This arrived at by dividing the total variable costs by the total number of output. AVC=TVC÷TQ=AFC.
- Average Fixed Cost (AFC): This is the fixed cost of producing a unit of output and it is calculated as: AFC = TFC÷O = ATC - AVC
- Marginal Cost: This is the cost difference in producing an additional unit of a firm's output. This extra amount results from an extra unit of output produced. For instance, if the cost of producing 4 commodities is N10.00, and it costs N12.50 produce 5 of the same commodity, therefore, the N2.50 difference in cost is known as marginal cost. It is calculated as: MC= Change in TC÷Change in Output= DTC÷DQ Click here to check: Cost of production Schedule
The short-run is a production planning period in which at least one factor of production is fixed in supply. In this period, a firm cannot vary all factors of production I.e, only those called variable factors such as land, building, heavy machinery and top management posts are called fixed factors of production. In this period, the only way output can be increased is by employing more units of the variable factors of production and the fixed factor used more efficiently and intensively. A distinction can be made between variable and fixed costs of production in the short-run.
On the other hand, the long run is a production planning period in which a firm can vary all the factors of production to be in line with the level of demand. In this long run, no factor is fixed, all factors and costs are variable. The short-run and long run costs are therefore, two different time horizons that are necessarily planning concepts for productive firms.
DISTINCTION BETWEEN ECONOMIST'S AND ACCOUNTANT'S VIEW OF COST
The Economists view cost not necessarily in terms of expenditure incurred but in terms of the alternative forgone which we called "opportunity cost". Therefore, to the Economists, the alternative forgone or the sacrifice is the opportunity costs or real cost or true cost. The money spent on a commodity that was left unbought in order to purchase that commodity bought.
On the other hand, the Accountants view cost in terms of the amount of money spent in order to have a commodity or service. That is, the Accountants view cost in terms of payment and this is what in Economics is called money cost. In a bid to show more distinction between Economist's and Accountant's views of cost, we shall differentiate opportunity cost from money cost.
OPPORTUNITY COST AND MONEY COST
Opportunity cost which is also known as real cost or true cost refers to the want that was left unsatisfied in order to satisfy another more pressing want. Money cost on the other hand, refers to the amount of money paid for a particular item. For instance, a student who has N10 and two pressing wants of buying a textbook and a shirt which cost N10 each. The student has to choose to buy one of the commodities at the expense of the other as a result of his limited available resources (money) used in satisfying the wants. If the student decides to buy textbook and forego the shirt, therefore, N10 is the money cost of the textbook he bought while the opportunity cost or the real cost or the true cost of the textbook is the shirt which he failed to buy with the same money.
REVENUE CONCEPT
The term revenue simply means the income earned by a firm from the sale of its commodities. In the case of government, revenue comprises taxes of and income from other sources.
The concepts used under revenue are as follows:
- Total Revenue (TR): This is the total amount of income earned from the sale of a specified unit of a product. It is calculated as: TR=Average revenue × Quantity sold.
- Average Revenue (AR): This refers to increase in total revenue as a result of selling one more unit of a product. It is calculated as follows: MR = Change in TR ÷ Change in Q = DTR÷DQ click here to check: Revenue Schedule
Profit is the excess of revenue over cost of profit. If otherwise it is loss.
Profit is usually calculated as follows:
Profit = TR-TC
= (AR×Q) - (TFC+TVC)
= Price × Q - (ATC × Q).
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