This document discusses the key concepts of cost in economics. It defines cost as the amount paid to acquire goods and services, including both explicit accounting costs like wages and supplies, as well as implicit economic costs like investment returns. It then categorizes costs as outlay, opportunity, direct, indirect, fixed, and variable costs. It introduces the cost function formula and explains the relationships between total, average, marginal, short-run, and long-run costs and production output. Key points are illustrated with examples.

1. THEORY OF COST
Submitted by: Bhawna

2. Cost
The concept of cost is a key concept in Economics. It refers to the
amount of payment made to acquire any goods and services. In a
simpler way, the concept of cost is a financial valuation of resources,
materials, risks, time and utilities consumed to purchase goods and
services.

3. TYPES OF COST
● Accounting Costs / Explicit Costs
The cost of production including employee salaries, raw material cost, fuel costs, rent
expenses and all the payments made to the suppliers from the accounting costs.
● Economic Costs / Implicit Costs
According to the modern theory of cost in economics, the investment return amount of a
businessman, the amount that could have been earned but not paid to an entrepreneur
and monetary rewards for all estates owned by the businessman form the economic
costs.

4. TYPES OF COST
● Outlay Costs
These are the recorded account costs or actual expenditure spent on wages,
rent, raw materials and more.
● Opportunity Costs
These are the missed opportunity costs. They are not recorded in the account
books but show the cost of sacrificed or rejected policies.
● Direct / Traceable Costs
These costs are easily pointed out or identified expenditures such as
manufacturing costs. Such costs cater to specific operations or goods.

5. TYPES OF COST
● Indirect / Non-Traceable Costs
These costs are not related directly or identifiable to any operation or service. Costs such as
electric power or water supply are some examples because these expenses vary with output.
They generally have a functional relationship with production.
● Fixed Costs
Such costs do not vary with output and are fixed expenditure of the company. For example,
taxes, rent, interests are all fixed costs as they do not vary within a constant capacity. Any
company cannot avoid these costs.
● Variable Costs
These costs vary with output and are known as a variable cost. For example, salaries of the
employee, raw material costs all fall under variable costs. These directly depend on the fixed
amount of resources.

6. COST FUNCTION
The cost function measures the minimum cost of producing a given level of output
for some fixed factor prices. The cost function describes the economic possibilities
of a firm. Cost functions are important in studying the determination of optimal
output choices.
The general form of the cost function formula is C(x)=F+V(x) C ( x ) = F + V ( x )
where F is the total fixed costs, V is the variable cost, x is the number of units, and
C(x) is the total production cost.

7. COST OUTPUT RELATIONSHIP
The cost-output relationship plays an important role in determining the optimum level of production. Knowledge of
the cost-output relation helps the manager in cost control, profit prediction, pricing, promotion etc. The relation
between cost and its determinants is technically described as the cost function.
C= f (S, O, P, T ….)
Where;
C= Cost (Unit or total cost)
S= Size of plant/scale of production
O= Output level
P= Prices of inputs
T= Technology

8. TOTAL COSTS
For any business,
Total Costs (TC) = Total Fixed Cost (TFC) + Total Variable Cost (TVC).
Total fixed cost (TFC) is constant regardless of how many units of output are
being produced. Fixed cost reflect fixed inputs.
Total variable cost (TVC) reflects diminishing marginal productivity -- as more
variable input is used, output and variable cost will increase. As the additional
variable input leads to a smaller increase in production (diminishing marginal
productivity), a business must spend more on variable inputs to produce one more
unit of output.

9. MARGINAL COST
Marginal cost is the change in total production cost that comes from making or
producing one additional unit. To calculate marginal cost, divide the change in
production costs by the change in quantity. The purpose of analyzing marginal
cost is to determine at what point an organization can achieve economies of scale
to optimize production and overall operations. If the marginal cost of producing
one additional unit is lower than the per-unit price, the producer has the potential
to gain a profit.

10. SHORT RUN AVERAGE COST
If the estimate is done for a short period that does not consider the change in the
number of goods, it is called short-run average cost. We can derive it by dividing
the entire cost by the total number of goods that we want to produce.

11. LONG RUN AVERAGE COST
Long-run average total cost (LRATC) is a business metric that represents the
average cost per unit of output over the long run, where all inputs are considered
to be variable and the scale of production is changeable.

12. REFERENCES
● https://www.slideshare.net/ShompaDhali/theory-of-cost-117440614
● https://www.vedantu.com/commerce/theory-of-cost
● https://www.mbaknol.com/managerial-economics/cost-output-relationship/
● https://www.ag.ndsu.edu/aglawandmanagement/agmgmt/coursematerials/pro
ductiontheory/determiningcost

13. THANKYOU