Cost Terms

Fixed cost

costs that must be incurred in fixed quantity regardless of the level of output produced

Law of diminishing marginal returns

decrease in the marginal (per-unit) output of a production process as the amount of a single factor of production is increased, while the amounts of all other factors of production stay constant; in all productive processes, adding more of one factor of production, while holding all others constant ("ceteris paribus"), will at some point yield lower per-unit returns

Economic cost

depends on both the cost of the alternative chosen and the benefit that the best alternative would have provided if chosen; differs from accounting cost because it includes opportunity cost; equal to accounting cost plus implicit costscosts

Total cost

describes the total economic cost of production and is made up of variable costs, which vary according to the quantity of a good produced and include inputs such as labor and raw materials, plus fixed costs, which are independent of the quantity of a good produced and include inputs (capital) that cannot be varied in the short term, such as buildings and machinery; total cost in economics includes the total opportunity cost of each factor of production as part of its fixed or variable costs (variable cost plus fixed cost)

Explicit cost

direct payment made to others in the course of running a business, such as wage, rent and materials

Economic profit

equal to accouting cost minus implicit costs; similar to accounting profit but smaller because it reflects the total opportunity costs (both explicit and implicit) of a venture to an investor

Average total cost

equal to total cost divided by the number of goods produced (Q) or the sum of average variable costs (AVC) plus the sum of average fixed costs (AFC); may be dependent on the time period considered and affect the supply curve

Short run

some factors are variable and others are fixed, constraining entry or exit from an industry; time period when the general price level, contractual wage rates, and expectations may not fully adjust

Marginal cost

the cost of producing one more unit of a good; marginal cost at each level of production includes any additional costs required to produce the next unit

Average fixed cost

the fixed costs of production (FC) divided by the quantity (Q) of output produced; as the total number of units of the good produced increases, the average fixed cost decreases because the same amount of fixed costs is being spread over a larger number of units of output; AFC curve starts from a height and goes on declining continuously as production increases

Normal profit

the minimum level of profit that is needed to maintain long-term production of a particular product; occurs at the point at which the resources available to the firm are being efficiently used and could not be put to better use elsewhere

Implicit cost

the opportunity cost equal to what a firm must give up in order to use factors which it neither purchases nor hires (e.g., foregone income)

Total variable cost

the sum total of all those costs that change in direct proportion to the change in the quantity or volume of production; such costs include cost of raw materials, labor cost, cost of operations, variable overheads, packaging, etc; Total Variable Cost = Q * Variable Cost Per Unit

Long run

time frame in which the firm can vary the quantities used of all inputs, even physical capital; typical long-run average cost curve is U-shaped; the conceptual time period in which there are no fixed factors of production as to changing the output level by changing the capital stock or by entering or leaving an industry; the period when the general price level, contractual wage rates, and expectations adjust fully to the state of the economy

Average variable cost

variable costs (labor, electricity, etc.) divided by the quantity (Q) of output produced; they vary with output; average variable cost declines as the level of output increases at low levels of output, and then bottoms out and begins increasing as output increases further (U-shaped curve)