The cost, in the economy, business management, and accounting, indicates the expression in money or other numerical value of the goods and services used for the production or purchase of a good or service. It can be determined on the basis of internal assessments of the economic entity that holds it or in economic transactions with other economies.
Cost-of-production theory of value
The cost-of-production theory of value states that the price of an object or condition is determined by the sum of the cost of the resources that went into making it. The cost can comprise any of the factors of production (including labor, capital, or land) and taxation. Technology can be viewed either as a form of fixed capital (e.g. an industrial plant) or circulating capital (e.g. intermediate goods).
Production theory and utility theory interact to produce the theory of supply and demand, which determine prices in a competitive market. In a perfectly competitive market, it concludes that the price demanded by consumers is the same supplied by producers. That results in economic equilibrium.
In the mathematical model for the cost of production, the short-run total cost is equal to fixed cost plus total variable cost. The fixed cost refers to the cost that is incurred regardless of how much the firm produces. The variable cost is a function of the quantity of an object being produced. The cost function can be used to characterize production through the duality theory in economics, developed mainly by Ronald Shephard (1953, 1970) and other scholars (Sickles & Zelenyuk, 2019, ch.2).
Economists use the term opportunity cost to indicate what one must give up to obtain what he or she desires. In simple terms, opportunity cost is the benefit not received as a result of not selecting the next best option. The idea behind opportunity cost is that the cost of one item is the lost opportunity to do or consume something else. In short, opportunity cost is the value of the next best alternative. In many cases, it is reasonable to refer to the opportunity cost as the price.
Opportunity cost is closely related to the idea of time constraints. One can do only one thing at a time, which means that, inevitably, one is always giving up other things. The opportunity cost of any activity is the value of the next-best alternative thing one may have done instead. Opportunity cost depends only on the value of the next-best alternative.
Opportunity cost measures cost by what we forgo in exchange. Sometimes we can measure opportunity cost in money, but it is often useful to consider time as well, or to measure it in terms of the actual resources that we must forfeit.
Opportunity costs can tell when not to do something as well as when to do something. Opportunity costs are unavoidable constraints on behavior because one has to decide what’s best and give up the next-best alternative.
Identifying opportunity cost
In many cases, it is reasonable to refer to the opportunity cost as the price. If your cousin buys a new bicycle for $300, then $300 measures the amount of “other consumption” that he has forsaken. For practical purposes, there may be no special need to identify the specific alternative product or products that he could have bought with that $300, but sometimes the price as measured in dollars may not accurately capture the true opportunity cost. This problem can loom especially large when costs of time are involved.
For example, consider a boss who decides that all employees will attend a two-day retreat to “build team spirit.” The out-of-pocket monetary cost of the event may involve hiring an outside consulting firm to run the retreat, as well as room and board for all participants. However, an opportunity cost exists as well: during the two days of the retreat, none of the employees are doing any other work.
Attending college is another case where the opportunity cost exceeds the monetary cost. The out-of-pocket costs of attending college include tuition, books, room and board, and other expenses. However, in addition, during the hours that you are attending class and studying, it is impossible to work at a paying job. Thus, college imposes both an out-of-pocket cost and an opportunity cost of lost earnings.
- Principles of Economics 2e. OpenStax. Authors: Steven A. Greenlaw, David Shapiro. https://openstax.org/books/principles-economics-2e/pages/1-introduction