Economic cost

Economic cost

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The economic cost of a decision depends on both the cost of the alternative chosen and the benefit that the best alternative would have provided if chosen. Economic cost differs from accounting cost
Historical cost
In accounting, historical costs is the original monetary value of an economic item. Historical cost is based on the stable measuring unit assumption. In some circumstances, assets and liabilities may be shown at their historical cost, as if there had been no change in value since the date of...

 because it includes opportunity cost
Opportunity cost
Opportunity cost is the cost of any activity measured in terms of the value of the best alternative that is not chosen . It is the sacrifice related to the second best choice available to someone, or group, who has picked among several mutually exclusive choices. The opportunity cost is also the...

.

As an example, consider the economic cost of attending college. The accounting cost of attending college includes tuition, room and board, books, food, and other incidental expenditures while there. The opportunity cost of college also includes the salary or wage that otherwise could be earning during the period. So for the two to four years an individual spends in school, the opportunity cost includes the money that one could have been making at the best possible job. The economic cost of college is the accounting cost plus the opportunity cost.

Thus, if attending college has a direct cost of $20,000 dollars a year for four years, and the lost wages from not working during that period equals $25,000 dollars a year, then the total economic cost of going to college would be $180,000 dollars ($20,000 x 4 years + the interest of $20,000 for 4 years + $25,000 x 4 years).

Components of Economic Costs

  • Total cost
    Total cost
    In economics, and cost accounting, total cost describes the total economic cost of production and is made up of variable costs, which vary according to the quantity of a good produced and include inputs such as labor and raw materials, plus fixed costs, which are independent of the quantity of a...

     (TC): Total Cost equal fixed cost plus variable costs. TC = FC + VC.
    • Variable cost
      Variable cost
      Variable costs are expenses that change in proportion to the activity of a business. Variable cost is the sum of marginal costs over all units produced. It can also be considered normal costs. Fixed costs and variable costs make up the two components of total cost. Direct Costs, however,...

       (VC): Variable costs are the costs paid to the variable input. Inputs include labor, capital, materials, power and land and buildings. Variable inputs are inputs whose use vary with output. Conventionally the variable input is assumed to be labor.
      • Total variable cost (TVC) or (VC) total variable costs is the same as variable costs.
    • Fixed cost
      Fixed cost
      In economics, fixed costs are business expenses that are not dependent on the level of goods or services produced by the business. They tend to be time-related, such as salaries or rents being paid per month, and are often referred to as overhead costs...

       (FC) fixed costs are the costs of the fixed assets those that do not vary with production.
      • Total fixed cost (TFC) or (FC)
  • Average cost
    Average cost
    In economics, average cost or unit cost is equal to total cost divided by the number of goods produced . It is also equal to the sum of average variable costs plus average fixed costs...

     (AC) average cost are total costs divided by output. AC = FC/q + VC/q
    • Average fixed cost (AFC) = fixed costs divided by output. AFC = FC/q. The average fixed cost function continuously declines as production increases.
    • Average variable cost
      Average variable cost
      Average variable cost is an economics term that refers to a firm's variable costs divided by the quantity of output produced...

       (AVC) = variable costs divided by output. AVC = VC/q. The average variable cost curve is typically U-shaped. It lies below the average cost curve and generally has the same shape - the vertical distance between the average cost curve and average variable cost curve equals average fixed costs. The curve normally starts to the right of the y axis because with zero production
  • Marginal cost
    Marginal cost
    In economics and finance, marginal cost is the change in total cost that arises when the quantity produced changes by one unit. That is, it is the cost of producing one more unit of a good...

     (MC)
  • Cost curve
    Cost curve
    In economics, a cost curve is a graph of the costs of production as a function of total quantity produced. In a free market economy, productively efficient firms use these curves to find the optimal point of production , and profit maximizing firms can use them to decide output quantities to...

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