Types of Business Costs

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There are many types of business costs involved in starting or running a business. This article looks in detail different types of business costs.

Economic Cost:  Also known as the "opportunity cost" is a payment made to obtain the services of a resource which is at least equal to what that resource can earn elsewhere. 

Opportunity cost: It is the net return that could be realized if a resource were put to its next best use. It is "what we give up" from "the road not taken." 

Implicit costs:  The monetary income that a firm gives up when it uses a resource that it owns rather than buying it from the market.  In other words implicit costs are opportunity costs of owner owned resources including the services of the entrepreneur-costs that are not paid but must be taken into account to estimate the total cost 

Explicit costs:  The monetary payment a firm must make to an outsider to obtain a resource. 

Total costs:  The costs of all resources paid (explicit) and not paid (implicit)  

Accounting profit:  Is the difference between total cost explicit costs 

Normal profit: Is the opportunity cost of the entrepreneur (owner) - the minimum income that the entrepreneur must receive to perform the entrepreneurial functions for the firm. 

Economic profit:  The total revenue of a firm less all its economic costs; also called "pure profit" and "above normal profit." 

Short run:  A period of time so short that quantity of all inputs cannot be changed and at least one input (usually the plant) remains fixed or unchanged. New firms do not enter the industry, and existing firms do not exit. 

Long run:  A period of time long enough in which the quantity of all inputs can be changed-increased or decreases. New firms can enter and exit the market place 

Fixed costs:  Costs of inputs that do not change in a given period known as the short run. 

Variable costs: Cost of inputs that can change even in the short run. 

Relevant costs: These are costs that are relevant with respect to a particular decision. A relevant cost for a particular decision is one that changes if an alternative course of action is taken. Relevant costs are also called differential costs. Relevant costs are decision specific, meaning that a relevant cost may be important in one situation but irrelevant in another. They are also called incremental costs by accountants. 

Sunk costs: These are costs that were incurred in the past. Sunk costs are irrelevant for decisions, because they cannot be changed. Sunk costs are unrecoverable past expenditures. These should not normally be taken into account when determining whether to continue a project or abandon it, because they cannot be recovered either way.

A summary of costs, revenues, and profits

        Total costs = Rents + Wages + Interest + Normal profit
                        = Explicit costs + Implicit costs
                        = Fixed costs + Variable costs

Accounting profit = Total revenue (income) - Explicit costs

  Economic profit = Accounting profit - Implicit costs

                        = Total revenue - (Explicit costs +
                           Implicit costs)

                        = Total revenue - Total costs

 

 

     
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