Measuring Cost: Which Costs Matter?
Accounting cost – Actual expenses plus depreciation charges for capital equipment.
Economic cost – Cost to a firm of utilizing economic resources in production.
Opportunity cost – Cost associated with opportunities forgone when a firm’s resources are not put to their best alternative use.
Economic cost = Opportunity cost (if we measure all of firm’s resources properly)
Sunk cost – Expenditure that has been made and cannot be recovered.
Total cost – Total economic cost of production, consisting of fixed and variable costs. Fixed costs – Cost that does not vary with the level of output and that can be eliminated only by shutting down
Variable cost – Cost that varies as output varies
Amortization – Policy of treating a one-time expenditure as an annual cost spread out over some number of years.
Marginal cost (MC) or incremental cost – Increase in cost resulting from the production of one extra unit of output.
MC = ΔVC = ΔTC
Δq Δq
Average total cost = (FC+AC)/q
Average fixed cost = FC/q
Average variable cost = VC/q
