Depending on the purpose, costs are classified into a number of ways. Let us examine the following ones which are highly relevant to our analysis of costs.
1. Explicit and Implicit Costs:
Explicit costs are costs of external factors of production none of which is owned by the producer. Costs of inputs such as raw materials purchased and labour employed are two examples of explicit costs. Electricity consumed in production is yet another example.
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As against this, costs of factors owned and provided by the producer himself are implicit costs. Examples are the costs of self-provided land- building, financial capital and entrepreneurial skills. Thus, rent, interest and the entrepreneur’s opportunity cost comprise implicit costs.
From the viewpoint of an accountant, the total cost of production comprises only the explicit costs, while from the viewpoint of an economist; it comprises both, the explicit costs and the implicit costs. The accountant’s concept treats implicit costs as a part of the firm’s profit while that of an economist treats them as a part of the total cost.
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2. Money Costs and Real Costs:
Money costs, also known as private costs, refer to total expenses incurred by producers in monetary terms on production. Such costs include costs of those factors of production in respect of which monetisation are possible.
For instance, determination of money value of the services of labour is possible through price mechanism, but that in respect of pains suffered by that an entrepreneur day and night to ensure smoothness in production is not.
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No money value can serve as an adequate compensation to an entrepreneur for the pains he takes, leave alone his opportunity cost. There are no price tags possible for anxiety suffered and leisure sacrificed.
Such qualitative aspects are highly difficult, if not impossible, to monetise. Likewise, monetisation of the sufferings of society from noise and air pollution is also equally difficult. Such costs, called external costs, therefore, fail to enter into the money costs of production. Real costs comprise money costs as well as external costs.
3. Sunk Costs and Future Costs:
An expenditure already incurred in the past is called a sunk cost provided it is not possible to recover or withdraw it. For example, costs incurred on digging the ground for building a house are irrecoverable, while those incurred on the purchase of a machine or a house are recoverable through resale of the asset.
Sunk costs are said to be irrelevant in decision making. Once incurred, they become unavoidable costs. On the other hand, future costs are costs to be incurred in future. For example, costs emanating from an anticipated change in the level of output or those emanating from expansion of plant size are the future costs, which, by all means are avoidable. Such costs can be avoided if desired and are thus highly relevant from the viewpoint of decision making.
4. Private Costs and Social Costs:
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Private costs, also known as money costs, refer to the costs of production actually incurred in terms of money by a firm. On the other hand, social costs refer to costs incurred by the society as a whole.
They include private costs as well as costs of sufferings of the society (external costs) caused by noise and air pollution. As seen earlier, the latter component of social costs is a non-monetised one.
Social costs may thus be higher or lower than private costs depending on the sign of the external costs, whether it is positive or negative. The concept of social costs is of high significance in social cost and benefit analysis.
5. Fixed and Variable Costs:
Fixed costs refer to costs of fixed factors of production. Land, building, plant, equipment and machinery are some examples of fixed factors of production. Fixed costs remain fixed whether output produced is high or low or zero.
Cost of all the fixed factors taken together is termed as the total fixed cost (TFC). Figure 5.1 shows the behaviour of TFC curve in relation to the level of output.
As against this, the variable cost varies with the level of output. These costs refer to the costs of variable factors of production. Examples are costs of raw materials, labour, power, fuel and depreciation.
Such costs increase with an increase in the level of output. Costs of all the variable factors taken together are termed as the total variable cost (TVC). The total variable cost as a function of output is portrayed in Figure 5.2.
