Economic and Accounting Costs in Business Production

Economic and Accounting Costs

Accounting cost is the actual cost plus expenses of depreciation of capital equipment. Economic cost is the cost for a company that utilizes financial resources in production, including the opportunity cost.

Opportunity Cost

Opportunity cost is the cost of the opportunity lost by not utilizing the company's resources for an alternative of greater value. Both accountants and economists include the cost of real money, known as cash flows, in their calculations. These include:

• Salaries and wages
• Cost of raw materials
• Leases of real property

Sunk Costs

A sunk cost is a cost that has already been incurred and cannot be recovered. They are usually visible, but once they have been spent, they should always be left aside when making economic decisions. Since they are impossible to recover, they must not influence the company's future decisions.

Short-Term Costs

In the short term, one or more factors of the company are held fixed. Total costs can be divided into fixed cost and variable cost. The marginal cost of an enterprise is the additional variable cost for each additional unit of production. The average variable cost is the total variable cost divided by the total number of units of production.

In the short run, when not all factors are variable, the presence of diminishing returns determines the shape of cost curves. In particular, there is an inverse relationship between the marginal product of a single variable factor and the marginal costs of production. The variable cost curves and average total cost are U-shaped. The marginal cost curve trends upward in the short term once beyond a certain point and cuts the average cost curves from below at their minimum points.

Long-Term Costs

In the long run, all factors that intervene in the production process are variable. Therefore, the choice of factors depends on the relative costs of factors of production and the degree to which the firm can substitute some other factors in its production process. The choice of cost-minimizing factors is determined by finding the point of tangency between the isoquant (representing the desired level of production) and the isocost. The expansion path provides useful information relevant to long-term planning decisions.