The cost concept in economics tells us how expensive it will be to carry out the production of a certain good or service. Since production costs are important in determining a firm’s output, it is important that you know in detail about cost concept in economics.
Meaning of Cost Concept in Economics
A firm uses various inputs for the production of goods and services. The firm has to make payments for such inputs as they are not free. The expenditure incurred on these inputs is known as the cost of production in economics. The concept of cost in economics refers to the total expenditure incurred in producing a commodity. In, economics, cost is the sum total of – explicit cost and implicit cost.
- Explicit Cost – Explicit cost refers to the actual money expenditure on inputs or payment made to outsiders for hiring their factor services. For example, wages paid to the employees, rent paid for hired premises, payment for raw materials etc.
- Implicit Cost – Implicit cost is the estimated value of the inputs supplied by the owners including normal profit. For example, interest on own capital, rent of own land, salary of the owners including normal entrepreneur etc. Such costs are the costs of self-supplied factors.
So, the concept of cost in economics includes actual expenditure on inputs (i.e, explicit cost) and the imputed value of the inputs supplied by the owners (i.e. implicit cost). Economic cost of production includes not only the accounting cost, which is the explicit cost, and the imputed value, which is the implicit cost. The sum of explicit cost and implicit cost is the total cost of production of a commodity.
The relation between cost incurred and output is known as ‘Cost Function’. Cost function refers to the functional relationship between cost and output. It can be expressed as,
C = f (q)
C = Cost of production
q = Quantity of output
f = Functional relationship
Opportunity Cost in Production
We know that opportunity cost is the cost of the next best alternative foregone. The concept of opportunity cost is very important as it forms the basis of the concept of cost. When a firm decides to produce a particular commodity, then opportunity cost always considers the value of the alternative commodity, which is not produced. The value of the alternative commodity is the opportunity cost of the good that the firm is now producing.