PRODUCTION MANAGEMENT (Q & A2)

PRODUCTION MANAGEMENT

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Question:

Explain each of the following cost concepts:

a.      Historical Cost

b.      Implicit Cost

c.       Marginal Cost

d.      Long-run cost 

ANSWER:

HISTORICAL COST: This refers to the cost of an asset acquired in the past.  It is used for accounting purposes, in the assessment of the net worth of the firm. 

IMPLICIT COST:  Costs which do not take the form of cash outlays, nor do they appear in the accounting system are known as implicit or imputed costs:  Opportunity cost is an important example.  For example, suppose an entrepreneur does not utilize his services in his own business and works as a manager in some other firm on a salary basis, if he sets up his own business, he foregoes his salary as manager. This loss of salary is the opportunity cost of income from his own business.  

This is an implicit cost of his own business.  Thus, implicit wages, rent and implicit interest are the wages, rent and interest which an owner’s labour, building and capital, respectively, can earn from their second best use.  

Implicit costs are not taken into account while calculating the loss or gains of the business, but they form an important consideration in whether or not a factory would remain its present occupation.  The explicit and implicit costs together make the economic costs. 

MARGINAL COST (MC) is the addition to the total cost on account of producing one additional unit of the product.  Or marginal cost is the cost of the marginal unit produced.   Marginal cost is calculated as TC_n-TC_n-1

Where n is the number of units produced.  Alternatively, given he cost function, MC can be defined as MC = dTC/dQ.

LONG-RUN COSTS: The analysis of short-run Costs reveals how a firm’s costs will vary in response to output changes within the limits of a time period short enough so that the size of the plant may be regarded as fixed.  By extending the logic one step further, it is possible to develop a long-run cost curve or function which correspondingly, is one that shows the variation of cost with output for a period long enough so that all productive factors, including plant and equipment, are variable. 

The knowledge of such a long-run cost curve, or planning curve as it is also called, can be of use to management ;

i.                    In determining output rates over periods long enough so that  assets acquired for use during the period can be fully extinguished, and

ii.                  In establishing rational policies as to optimum plant size, location, and general operational standards. 

Long-run costs are by implication the same as fixed costs.  In the long-run, however, even the fixed costs become variable costs as the size of the firm or scales of production increases.  Broadly speaking, long-run costs are associated with the changes in the size and kind of plant.