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Cost
 

 

Broadly, the measure of what has to be given up in order to achieve something. Two concepts of cost can be distinguished which may, but need not, be equivalent:

(a) opportunity cost: in economics, it is considered appropriate to define cost in terms of the value of the alternatives or other opportunities which have to be foregone in order to achieve a parficular thing. This will coincide with outlays (see below) if, and only if, the prices with which the outlays are calculated correctly reflect the value of alternative uses of the resources.

(b) outlays: an accountant would define the cost of something as the total money expenditure or outlays necessary to achieve it. As an example of the meaning of opportunity cost, and the distinction between this and outlays, take the situation in which a firm is considering expansion in output of one of its products. This involves purchasing certain inputs - raw materials, labour, new machinery, etc: and also, we assume, diverting certain resources already possessed to the production of the good - warehouse and factory space, for example. Assume also that the finance for capita! expenditure is provided out of retained earnings. The total cost of increasing production in. terms of outlays would be the sum Qf expenditure on materials and new machinery, the wages of the additional labour assigned to this product and the salary bill of extra managers assigned to it plus a proportion of overheads. The opportunity cost of the increased production, however, will consist of (i) the outlays on the increased amounts of inputs bought in, (ii) loss of profit which may result from cutting down the production of other goods in order to release warehouse and factory space and divert it to the product whose output is being increased, and (iii) the cost of financing the capita] expenditure, which is equal to the rate of return which the firm could have obtained on the funds used to expand production if they had been used in the next most profitable opportunity open to the firm, whether internal or external.

The principle of opportunity cost involves asking what is actually foregone by choosing a particular alternative. This concept is preferJed by economists, because it leads to a more rational process of decisiontaking against which the retums from a course of action are compared to the-real cost involved in undertaking it. The difference in approach to the meaning of cost between the economist and accountant can be attributed to the fact that the economist is primarily interested in optimal dedsion taking, whereas the accountant has been traditionally more concerned with the ex-post recording and presentation of money flows.

 

Reference: The Penguin Business Dictionary, 3rd edt.