This document discusses key concepts related to cost analysis in economics. It defines cost analysis as an economic evaluation technique used to systematically collect, categorize and analyze costs. Costs can be classified as explicit costs, which involve direct payments, and implicit costs, which represent foregone opportunities. The document also discusses the differences between accounting costs reported on financial statements and economic costs from the perspective of opportunity cost. It explains total, average and marginal costs in both the short run and long run for firms.

1. December 8, 2012

2. Prepared by
 Ali Abbas
 Aneel Usmani
 Arif Deen
 M. Atiq
 Naveed Ali
Presented to
 Mr. Shujaat Mubarik

3. 
It is an economic evaluation technique

It involves the systematic collection,
categorization, and analysis of costs

It can also be used within the frameworks of
 Cost-effectiveness analysis
 Cost-benefit analysis
 Cost-utility analysis

4. 
Costs are the values of all the resources used
to produce a good or a service

Economists think of costs as consequences of
choices

i.e., the value of benefits that would have
been derived if the resources had been
allocated to their next best use

5. Explicit Costs:
 The costs that involve an actual payment to other parties

The monetary payment made by a firm for use of an input owned
or controlled by others
Implicit Costs:
 Represent the value of foregone opportunities but do not involve
an actual cash payment

Implicit costs are just as important as explicit costs but are
sometimes neglected because they are not as obvious

Implicit cost is the opportunity cost of using resources that are
owned or controlled by the owners of the firm

6. 
Accountants have always been concerned
with firms’ financial statements

Accountants tend to evaluate past
performances

The accounting costs are useful for managing
taxation needs as well as to calculate profit or
loss of the firm

7. 
Economists take forward-looking view of the
firm

They are concerned with what cost is
expected to be in the future and how the firm
might be able to rearrange its resources to
lower its costs and improve its profitability

They are concerned with opportunity cost

8. 
To produce more, a firm must employ more labour which means it
must increase its costs

The following concepts are important in the short run
 Total Cost (TC):
The cost of all the factors of production it uses.
 Marginal Cost:
The increase in the total cost that results from a one unit increase in
output.
 Average Cost:
The average cost includes three factors of production i.e., average
fixed cost, average variable cost, average total cost

9. It includes:

Total Fixed Cost (TFC):
The cost of the firm’s fixed factors

Total Variable Cost (TVC):
The cost of the firm’s variable factors

Equation:
TC = TFC + TVC

10. 
It includes

Average Fixed Cost:
The total fixed cost per unit

Average Variable Cost:
The total variable cost per unit

Average Total Cost:
The total cost per unit of output

Equation:
ATC= AFC + AVC

11. 
A firm can vary both the quantity of labour
and the quantity of capital

The firm’s costs are variable

The behavior of the long run cost depends on
the firm’s production function

12. 
Production Function:
The relationship of between the maximum output attainable and the quantities
of both labour and capital

Economies of Scale
They are the features of a firm’s technology that make average total cost fall as
output increases.

Diseconomies of Scale
They are features of a firm’s technology that make the average total cost rise as
output increases.

Constant returns to Scale
They are features of a firm’s technology that keep average total cost constant as
output increases.

Minimum efficient scale
It is a firm’s smallest output at which long run average cost reaches its lowest
level.

13. 
Explicit Cost
A firm pays Rs. 100 per day to a worker and
engages 15 workers for 10 days, the explicit
cost will be Rs. 15,000 incurred by the firm.
Other types of explicit costs include raw
material purchase, renting a building, amount
spent on advertising, utility bills etc.

14. 
Implicit Cost
A manager who runs his own business foregoes the
salary that could have been earned working for
someone else. This implicit cost is generally not
reflected in accounting statements, but ideally it
should be considered. Therefore, an implicit cost is
the opportunity cost of using resources that are
owned or controlled by the owners of the firm. The
implicit cost is the foregone return, the owner of the
firm could have received had they used their own
resources in their best alternative use rather than
using the resources for their own firm’s production.

15. 
Economic Profit and Accounting Profit
Mr. Ali is a small storeowner. He has invested Rs. 200,000 as equity
in the store and inventory. His annual turnover is Rs. 800,000, from
which he must deduct the cost of goods sold, salaries of hired
staff, and depreciation of equipment and building to arrive at
annual profit of the store. He asked help of a friend who is an
accountant by profession to prepare annual income statement.
The accountant reported the profit to be Rs. 150,000. Mr. Ali could
not believe this and asked the help of another friend who is an
economist by profession. The economist told him that the actual
profit was only Rs. 75,000 and not Rs. 150,000. The economist
found that the accountant had underestimated the costs by not
including the implicit costs of time spent as Manager by Mr. Ali in
the business and interest on owner’s equity.