Concept of Cost

In our daily life, we use various kinds of goods and services. Among the goods we use, some are freely obtained from nature. For example, air, minerals, sunlight and heat, river water, etc. These goods do not require any expenditure to obtain. On the other hand, some goods require the use of land, labor, capital, and entrepreneurship during production.

For example, a company that produces noodles uses land, labor, capital, raw materials, and entrepreneurship to produce those noodles. In this way, when goods are produced, the producer has to bear costs under headings like land rent, wages of labor, and entrepreneur’s profit. The expenses incurred during the production of goods and services is called the cost.

The concept of cost and cost concepts can be studied by dividing it into short-run and long-run.

Short-run Cost and Cost Concepts

The short-run is a period of time where some factors of production are fixed and some are variable during the production of goods and services. In the short run, land, capital, and entrepreneurship are considered fixed, while labor is considered variable. The costs incurred in using fixed factors are called fixed costs, while costs incurred in using variable factors are called variable costs.

Short-run costs and cost concepts can be divided into total, average, and marginal costs and cost concepts.

Total Cost and Total Cost Concepts

When producing a specific unit of any good or service, various types of costs are incurred. For example, when producing a good, the producer must pay for rent of the land, wages for labor, interest for capital, profit for entrepreneurship, cost for raw materials, and advertising expenses. 

The sum of all the costs or the total amount paid during the production of a specific unit of the good is called the total cost. Such costs are incurred from the preparation of infrastructure for the production of goods. As the production of goods increases, the total cost also increases.

In short, the total cost is the sum of total fixed costs and total variable costs. 

Total fixed costs refer to the sum of expenses incurred on fixed factors like land, buildings, vehicles, machines, etc. These costs are incurred even when production has not started or when the production quantity is zero. They remain the same regardless of the increase in production. 

Variable costs refer to the total expenses incurred on variable factors like labor and raw materials. These costs only appear after the production of goods starts. In other words, when the production quantity is zero, total variable costs are also zero. As production increases, total variable costs also increase. Therefore, short-run total cost is the sum of total fixed costs and total variable costs. It can be symbolically expressed as follows:

TC = TFC + TVC

Where:

• TC = Total cost
• TFC = Total fixed cost
• TVC = Total variable cost

The short-run total fixed cost, total variable cost, and total cost are also clearly shown in the following table:

Table 1.1: Short-run Total Fixed Cost, Total Variable Cost, and Total Cost

In Table 1.1, the total fixed cost is Rs. 60 even when the number of units produced is zero. As production increases up to the sixth unit, the total fixed cost remains constant at Rs. 60. However, the total variable cost is zero when the production of goods is zero. As production starts from one unit and increases gradually to six units, the total variable cost rises from Rs. 30 to Rs. 120.

Total cost is the sum of total fixed costs and total variable costs. Therefore, total cost is equal to the total fixed cost of Rs. 60 when the production of goods is zero. As the number of units produced increases, both the total variable cost and total cost increase. For instance, as production increases from one unit to six units, the total cost increases from Rs. 90 to Rs. 180.

In economics, the Total Fixed Cost Line shows the relationship between total fixed cost and the number of units produced. The Total Variable Cost Curve illustrates the relationship between total variable cost and the number of units produced. Similarly, the Total Cost Curve shows the relationship between total cost and the number of units produced.

Based on Table 1.1, the derived curves for total fixed cost, total variable cost, and total cost are shown in Graph 1.1.

Graph 1.1: Short-run Total Fixed, Total Variable, and Total Cost Curves

In Graph 1.1, the number of units produced is plotted on the X-axis, and the total fixed cost, total variable cost, and total cost are plotted on the Y-axis. The total fixed cost line is represented by the TFC curve. The total variable cost curve is denoted by the TVC curve, and the total cost curve is represented by the TC curve.

The TFC curve starts from the point on the Y-axis where the value is Rs. 60 and remains parallel to the X-axis as the production increases. This indicates that total fixed costs remain constant as the number of units produced increases. On the other hand, the TVC curve starts from the origin (0,0) and rises as the production increases. This shows that total variable costs increase as production increases.

The total cost curve, TC, represents the sum of TFC and TVC. As production increases, both the TFC and TVC curves rise, leading to an increase in the total cost.