Introductory Economics

Introduction

Introduction to cost Concept:

• Cost plays an important role in farm decision making. The producers are concerned about the cost of cultivation or production of a commodity as it affects the level of their farm activity or an enterprise. Therefore, decision on producing an additional unit of output crucially rests on the cost of producing an additional unit of output. A farmer or a producer can increase his/her income either by increasing production or by reducing the cost of production. Since the prices are not under the direct control of producers in the competitive market, the alternative to reduce the cost through rationalization of resource use is an important option. This however, can be done only if the individual has the necessary knowledge of the basic cost concepts and the skills to utilize this knowledge effectively in farm business.
• Cost is the value of the inputs that get used up in producing an output and hence the inputs are not available for alternate use anymore, i.e. the expenses incurred on different inputs in producing a given amount of a product in a particular time period. As for example, the cost of producing a unit of apple or tomato may work out to be Rs 5/kg or Rs 3/kg, etc. based on the valuation of the value of seed, fertilizers, plant protection chemicals, labour for different operations, irrigation, etc.
• In order to understand cost concepts, it is important to be familiar with the terminology used in cost theory. Economists use different names for cost components under different contexts. Some of the terms with the brief description are given as under.

1. EXPLICIT v/s IMPLICIT COSTS

• Computation of cost of cultivation of a crop or production of a product must consider all components of the costs. Often some of the items of cost are easy to comprehend and are considered in the estimation of total costs. However, as economists, it is important that the true costs of production of a unit of output must be ascertained. For this, it becomes important to take due note of the indirect costs that often get neglected in the simple financial analysis. So it is important to understand the two components of the total economic costs which are termed as the explicit and the implicit costs.
• There are some inputs or resources that are used in production of an output after they are procured from the market. When we purchase these inputs from the market we pay a given amount for its acquisition as per the prevailing market price. These cash costs of the factors of production are the prices at which farmer can make the purchase. Since such costs that are paid in cash are therefore termed as explicit costs. These costs are also known as accounting costs or cash costs. The examples of explicit costs are the cost of seed, fertilizers, wages for hired labour, etc.
• On the other hand, there exists a cost component for which direct cash payments are not made. These non-cash costs such as depreciation of buildings, machinery and equipments and cost of factors that are both owned and employed by the farmer are termed as implicit costs. These costs are also known as non cash costs. Examples of this cost component are the non-cash costs on account of depreciation of durable inputs such as farm machinery and equipments, family labour used, farm yard manure from owned sources etc. which are used in the production. The values of the inputs or services are accounted for in terms of depreciation, farmer’s own labour and capital, etc.

2. OPPORTUNITY COSTS

• All economic resources are productive and have alternate uses. It is the scarcity part or characteristic of the resource that makes us decide where to use the resource. Naturally, based on our best judgment the resource is used in one or the other activity. By not using the resource in a given activity we cannot get the return from that activity. Now the value of the returns sacrificed or foregone from the next best alternative is called opportunity cost. In farming, farmers don’t have to pay for their owned resources, viz., family labour, owned bullock labour, owned machinery, owned seed, etc. but in cost analysis the value of these owned resources are considered on the basis of opportunity costs.

3. REAL COSTS:

• Costs expressed at constant prices are called the real costs.

4. NOMINAL /MONEY COSTS:

• Per unit costs of production of output at current market prices are called nominal or money costs.

5. ECONOMIC COSTS:

• The economic costs are the sum total of the direct and indirect cost of production of a unit of the product. In the above mentioned terminology the economic costs would be stated as under.

Economic costs = Explicit costs + Implicit costs

6. DEFLATED COSTS:

• If the costs are deflated by general price index, then they are known as deflated costs.

7. SOCIAL COSTS:

• Generally, the economic activities may result in some activities or phenomena that may be detrimental to the society at large. As for example various production activities may lead to increased water, air or noise pollution, degradation of forest and range lands and general environment, health hazards etc. All this would result in some additional costs to the society at large. These costs are known as social costs or externalities.

8. HISTORICAL COSTS:

• Costs involved in the purchase of durable goods like land, building, machinery and equipments are known as historical costs.

9. REPLACEMENT COSTS:

• The replacements are the costs, required to be incurred to replace an old but in use asset or the equipment today at its market price. The difference between original purchase price and current price of the asset is called replacement cost. For example if a power sprayer, purchased 10 years ago at Rs 50,000 now costs Rs 75,000 at its market price, the difference of Rs 25,000 would be the replacement cost.

10. ESTABLISHMENT COSTS

• Construction of plant in any business activity entails some costs. Such costs are called establishment costs. They are also called first phase costs. For example, cost on account of establishment of a new factory, or cost of planting a new orchard, etc. would be termed as the establishment costs.
• Economic production processes require time to mature. Knowledge of cost function thus is a pre-requisite for optimal management of factors of production in planning periods.
• The planning period, in economic parlance, are categorized as the short and the long run.
• A period of time which is long enough to permit desired changes in output without altering the size of farm or the firm is called the short run or the short period. In the short run, pricing and output decisions are based on short run costs.
• On the other hand, a period of time which is sufficiently long for output to be altered by varying either the size of farm or making more intensive or a less intensive utilization of the farm is known as long run period. The long run cost curves have the crucial implications for the farm development and investment policies. Therefore, depending upon the length of planning periods the costs are also classified as short run costs and long run costs..