PRINCIPLES OF BUSINESS DECISIONS MODULE: COST ANALYSIS CONTENT Various concepts of cost ;Fixed cost and Variable cost Opportunity cost and Outlay cost Short term and Long term cost Explicit cost and Implicit cost Past and Future costs Economics and Accounting cost Out of pocket cost and Book cost Incremental and Sunk cost Avoidable and Unavoidable costs Replacement and Historical cost Shut down and Abandonment cost DETERMINANTS OF COST Introduction General Determinants Output Level Prices of factors of production Productivities of factors of production Technology COST OUPUT RELATIONSHIP Short Run Long Run OPTIMUM FIRM Meaning Short Run Long Run

1. PRINCIPLES OF
BUSINESS DECISIONS
(CBCS SYLLABUS)
SUBMITTED BY,
Anant Narayana Prabhu
Aiswarya Rajesh
Nikhil Biju
Gayathri V Menon
STUDENTS, DEPARTMENT OF FINANCE AND TAXATION,
BHARATA MATA COLLEGE,THRIKKAKARA, KOCHI

2. COST ANALYSIS

3. CONTENT
• Various concepts of costs
 Fixed cost and Variable cost
 Opportunity cost and Outlay cost
 Short term and Long term cost
 Explicit cost and Implicit cost
 Past and Future costs
 Economics and Accounting cost
 Out of pocket cost and Book cost
 Incremental and Sunk cost
 Avoidable and Unavoidable costs
 Replacement and Historical cost
 Shut down and Abandonment cost

4. • DETERMINANTS OF COST
 Introduction
 General Determinants
 Output Level
 Prices of factors of production
 Productivities of factors of production
 Technology
• COST OUPUT RELATIONSHIP
 Short Run
 Long Run
• OPTIMUM FIRM
 Meaning
 Short Run
 Long Run

5. Various concepts of costs
1.Fixed cost and Variable cost:
Fixed costs are those costs which remains fixed
irrespective of the quantity of output produced by a
business firm. Cost of machinery, equipment, land and
buildings, salaries and wages to permanent staff etc. are
examples of fixed costs. Whatever be the quantity of
production, be it high or low, it is to be incurred by a firm.

6. It should be remembered that fixed cost do not remain
constant for all times but it will remain constant only up
to a certain level of production. However fixed cost per
unit decreases with increase in output and increases with
decrease in output.
Variable cost are those costs which vary almost in direct
proportion to the volume of production. Cost of direct
material, direct labour and direct expenses such as electric
power, fuel etc. are examples. Variable cost per unit
remains constant but the total variable cost increases with
increase in output and decreases with decrease in output.

8. 2. Opportunity cost and Outlay cost
Factors of production can be put to
alternatives uses by a businessman. The same factors of
production which are used for the manufacture of a
particular product can also be used for producing
another product. Thus if a businessman decides to
produce one product by employing the available factors,
he has to forego the production of another product. This
is because the resources are scares and therefore they can
be utilized only for limited uses.

9. Opportunity cost arises when there are alternatives. If a
businessman chooses a particular course of action, he has
to forego another alternative course of action, and the cost
of the opportunity foregone is called opportunity cost.
Outlay cost are those cost which are actually
incurred by a business firm. Examples are payment of
salaries and wages, purchase of raw materials, plant,
machinery etc. As these costs are actually paid by a
business firm they are recorded in the books of accounts.

11. 3. Short term and Long term cost
Economics distinguish short run and long run
on the basis of time.
Short run cost are those costs which are incurred
in the short run and vary with the quantity of output
produced. All variable cost are short term cost.
Long run cost are those costs which are incurred
for increasing the level of production in the long run.
There is no fixed cost in long run.

13. 4.Explicit cost and Implicit cost
Explicit coat are contractual cash payments to
factors of production such as land, labour and capital.
Thus payment of rent, wages and salaries are explicit cost.
Implicit cost are non contractual and therefore they
do not involve cash payments. The cost of factors of
production owned by a firm and employed in its own
business is called implicit cost. Examples are rent on own
buildings, interest on own capital etc. They are opportunity
costs. They are also called as imputed cost.

15. 6.Economics and Accounting cost
The term cost in the eyes of an accountant and an
economist differs in meaning. The concept of cost used in
the accounting sense id called accounting cost and includes
only explicit cost . Examples are cost of raw materials,
wages and salaries etc.
The concept of cost used by economist is called
economic cost and includes both explicit and implicit costs.
Thus it includes not only the costs that involves actual cash
payments but also include those which do not include cash
payments.

17. 5.Past and Future costs
Past cost are those costs which are already
incurred by a business firm and recorded in the books of
accounts. As these costs are already incurred they are
used only for evaluation about the reasonableness of such
costs. They may be expired or unexpired.
Future costs are estimated costs that are expected
to be incurred in future. As future costs are not actually
incurred they do not find a place in the books of accounts.
Future costs are estimated for taking managerial
decisions.

18. 7. Out of pocket cost and Book
cost
Out of pocket costs are explicit costs which
require current cash payments. These are expenses of
routine nature such as wages, salaries, rent etc. Book costs
are implicit costs which do not require current cash
payments. Salary of the proprietor, interest on
proprietor’s own capital etc.

20. 8.Incremental and Sunk cost
Incremental cost is the increases in total cost as a
result of a change in the level or nature of business
activity.
It is useful in evaluating the impact of various alternative
decisions on total cost.
Sunk costs are those costs which are already incured
as a result of a past decision. As they are already incurred
they cannot be changed by a future decision. Purchase of
fixed assets and huge expenditure on advertisement are
examples.

22. 9.Avoidable and Unavoidable
costs
Avoidable costs are also known as escapable
costs. These are costs which can be avoided or reduced if a
business firm cut short its business activities. All variable
costs are avoidable costs. Unavoidable cost are those costs
which cannot be avoided if a business firm cut short its
activities. All fixed costs are unavoidable costs.

23. 10.Replacement and Historical
cost
Historical cost is the cost at which an asset is
originally purchased. Replacement cost is the current cost
of replacing an existing asset. The cost of an asset is
recorded in the books of accounts at the historical cost.
Historical cost is already incurred at a time when the price
level was low and hence it is irrelevant for taking future
decisions. Replacement cost is the cost at the present price
level and hence it is relevant for taking future decisions.

24. 11.Shut down and Abandonment cost
Shut down costs are the costs incurred at the time
of temporary suspension of production process. Examples
are cost of idle time of workers etc. Such costs can be saved
as soon as the production is continued. Abandonment
costs are 5the cost incurred for abandonment of an asset
at the time of completion of business activities like mining,
quarrying etc.

26. DETERMINANTS OF COST

27. INTRODUCTION
The cost of production of goods and services
depends on many forces and the list of theses
forces may vary from firm to firm in an industry
and also from one type of industry to another.

28. However, the general determinants of cost are
the following :
 Output Level
 Prices of factors of production
 Productivities of factors of production
 Technology

29. Output level
Total cost varies directly with output. The more
output a firm produces, the higher will be its
production cost and vise versa. This is because
increased use of raw-materials, labour etc. if the
increase is substantial, it requires more fixed
inputs like plant and equipment.

31. Prices of factors of production
Cost varies directly with the prices of factors of
production. In economics, there are four factors of
production- land, labour, capital and organisation . The
prices of these factors of production are rent, wages,
interest and profit respectively. When there is an increase
in any one or more of these factor prices, the total cost
increases.

32. Factors of production
• Land, labour, capital and
organisation.
Prices of factors of production
• Rent, wages, interest and profit
respectively.

33. Productivities of factors of
production
Productivity of an factor of production means the
contribution of a unit of that factor to output.
Production cost varies inversely with the productivities
of factors of production. The higher the productivity of
an input factor, the smaller the quantity of that factor
one needs to produce a given output and vise versa.

35. Technology
Cost varies inversely with technological progress.
Technological improvements lead to an increase in
the efficiency or productivity of factors of
production which in turn causes a reduction.

37. COST OUPUT RELATIONSHIP
• THE RELATIONSHIP BETWEEN COST AND OUTPUT IS CALLED COST FUNCTION.
• DEPENDS UPON THE PRODUCTION FUNCTION AND THE PRICE OF INPUTS
• COST FUNCTION IS EXPRESSED AS;
TC = f(Q)
WHERE TC = TOTAL COST
f = FUNCTION OF OR DEPENDS ON
Q = TOTAL OUTPUT
• THE GREATER THE OUTPUT GREATER WILL BE THE TOTAL COST
• SHORT RUN COST FUNCTION AND LONG RUN COST FUNCTION
• SHORT RUN IS APERIOD OF TIME SO SHORT THAT THE EXISTING PLANT AND
EQUIPMENTCANNOT BE VARIED
• ADDITIONAL OUTPUT CAN BE PRODUCED ONLY BY EXPANDING THE VARIABLE
INPUTS OF LABOUR AND RAW MATERIALS
• LONG RUN IS A PERIOD LONG ENOUGH TO VARY ALL INPUTS

38. COST OUTPUT RELATIONSHIP IN THE SHORT RUN
• IN THE SHORT RUN A CHANGE IN THE OUTPUT IS POSSIBLE ONLY BY MAKING
CHANGES IN THE VARIABLE INPUTS LIKE RAW-MATERIAL, LABOUR ETC.
• FIXED INPUT QUANTITY CANNOT BE INCREASED IN SHORT RUN
TOTAL COST
• TOTAL COST(TC) IN THE SHORT RUN CONSISTS OF TOTAL FIXED COST (TFC)
AND TOTAL VARIABLE COST(TVC)
TC = TFC + TVC
TVC =TC – TFC
TFC = TC – TVC
• TFC REMAINS FIXED IN ALL SITUATIONS.
• EVEN IF OUTPUT IS ZERO TFC WILL NOT BE ZERO.
• TVC INCREASES WITH INCREASE IN OUTPUT.
• THE INCREASE IN TOTAL COST IS ONLY DUE TO INCREASE IN VARIABLE COST.

39. AVERAGE COST (AC)
• AVERAGE COST ARE TOTAL COSTS DIVIDED BY THE NUMBER OF
UNITS PRODUCED.
AVERAGE COST = TOTAL OUTPUT
UNITS OF OUTPUT
• AVERAGE COST = AFC + AVC
• AC = TFC / TOTAL OUTPUT PRODUCED
MARGINAL COST
• MARGINAL COST IS THE INCREASE IN TOTAL COST AS RESULT
OF AN INCREASE INN OUTPUT BY ONE UNIT.
MC = CHANGE IN TC
CHANGE IN Q
• MC DECLINES AT FIRST AND THEN IT BEGINS TO RISE STARTING
FROM THE NEXT UNIT.
• AC CURVE IS U-SHAPED BECAUSE OF THE OPERATION OF THE
LAW OF VARIABLE PROPORTIONS.

40. COST OUTPUT RELATIONSHIP IN THE LONG RUN
• LONG RUN IS A PERIOD LONG ENOUGH TO VARY ALL INPUTS.
• THERE IS NO FIXED COST AND ALL COSTS AARE VARIABLE ONLY
• IT IS POSSIBLE TO INCREASE THE LEVEL OF PRODUCTION BY
EXPANDING THE EXISTING PLANT.
• AS ALL COSTS ARE VARIABLE IN THE LONG RUN THE COST OUTPUT
RELATIONSHIP IMPLIES RELATIONSHIP BETWEEN LONG RUN
AVERAGE COST AND TOTAL OUTPUT .
LONG-RUN MARGINAL COST CURVE (LMC)
• THERE IS A LONG RUN MARGINAL COST CURVE CORRESPONDING
TO LONG RUN AVERAGE COST CURVE.
• IT REPRESENTS THE COST OF PRODUCING AN ADDITIONAL UNIT OF
OUTPUT WHEN ALL INPUTS VARY.
• THE LMC CURVE IS DERIVED FRO THE SHORT RUN MARGINAL COST
(SMC) CURVE.

41. OPTIMUM FIRM

42. • Optimum –
The most favourable situation or level for
growth. It also mean efficient use of some material or
factors of production.
• Firm-
A business entity such as a corporation, limited
liability company, public limited company, sole
proprietorship, or partnership that has products or
services for sale.
Meaning

43. If we combine both the terms i.e. “OPTIMUM FIRM”
Optimum firm is that firm which fully utilizes its scale of
operation and produces optimum output with the
minimum cost per unit production.
It is also said to be the most efficient size firm.

44. • Firm would build scale of plant and operation it at a point
where average cost is at minimum.
• If the demand increases in this least cost output
• It can’t change fixed factors like land , building ,
machinery etc but can make changes in variable factors
like labor , material etc
• It move in the same scale
• ATC begins to rise due to this diseconomies of scale
In Short-Run

45. • All the factors inputs are variable inputs
• Size of the firm can change according to the demand for the
product.
• If the size increase to satisfy the increasing demand , average
cost per unit begins to fall due to economies of scale
• As in long run there can be changes done in inputs either it can
be variable or fixed inputs such as specialization of labor,
efficient utilization of resource etc.
• Due to these reasons AC declines as long as its used efficiently.
In Long-Run

47. THANK YOU