Cost Analysis – Costs

Costs are also classified on the basis of their traceability. The costs which can be attributed to a product, a department, or a process are the separable costs, and the rest are non-separable or common costs. For example, in a multi product firm raw materials cost is separable for each product but the management cost is not separable that way. Similarly, in a university, while professors’ costs are separable department wise vice chancellor’s cost is not separable that way. In an educational institution like and Indian Institute of Management, even the Professors’ costs are not separable by its academic activities for professors work comprises of teachings in several degree and training programs, research, consulting and administration .

The distinction between separable and common costs, which are also referred to as direct and indirect costs, respectively, is of significance particularly in a multi-product firm. Costs play an important role in pricing. It will not be possible to estimate production costs by product in a multi product firm and consequently there would be difficulties in setting economic prices for different products. In actual practice, firms allocate common costs among various departments, processes or products though their approximate uses in various activities, which is often judged on the basis of their relative turnovers.

Private costs refer to the costs incurred by an individual firm while social costs stand for the costs incurred by the society as a whole. The former is the sum total of explicit and implicit costs that a firm incurs on the production of a good. These differ from the cost incurred by the society on two counts: exclusion or inclusion and externalities. There are costs lie taxes, which are costs to the firm but not to the society. Like wise, subsidies that a firm receives result in cost saving to a firm but not to the society. Externalities refer to the side effects which the working of a firm creates on the society. Or example, it might lead to air, water or noise pollution, traffic congestion, and accidental hazards. These are costs to the society though not to the firm. A firm could also lead to some social benefits or negative social costs. For example, development of a swimming pool, dam or rose garden would result in an increase in the value of surrounding properties and thereby create social benefits. Both exclusions / inclusions and externalities give rise to social costs and social benefits, they do not necessarily cancel out. Consequently the distinction between private and social cost is significant.

Total cost (TC) is the sum total of explicit costs. Just as there are averages and marginal revenues, and averages and marginal productivities, there are average and marginal costs. The former stand as for per unit cost and can be computed simply by dividing total cost by quantities of output produced. The marginal cost (MC) constitutes the change in total cost as output changes by an infinitesimally small unit. In case of discrete data, there is only marginal cost, which is defined as the change in total cost divided by change in output. For computing even marginal cost one needs data on two different levels of output and corresponding total cost.

Long and short run costs are related to long and short run production functions. The former refers to costs when all factors of production are subject to change, while the latter stands for costs when at least one of the factors of production is fixed. The fixed factor (s) is usually taken to limit the production capacity. Thus, long run costs refer to costs across all possible capacities while short run costs stand for costs within a given production capacity.

In the long run all costs are variable costs while in short run, some costs are fixed and some are variable. Combining this classification with the earlier one between total, average and marginal costs, there are three long run costs concepts and seven short run ones. The former consists of long run total cost (LTC), long run average cost (LAC) and long run marginal cost (LMC), and the latter comprises of short run total cost (STC) short run average total cost (SAC) short run marginal cost (SMC), short run total fixed cost (TFC) short run average fixed cost (AFC), short run variable cost (TVC) and short run average variable cost (AVC) .It is obvious that


Both long run and short run costs are useful for decision making. In the long run a firm is concerned with the optimum plant (firm) size and in the short run, it is concerned with optimum output within a given plant size.