Economic cost

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The economic cost of a decision depends on both the cost of the alternative chosen and the benefit that the best alternative would have provided if chosen. Economic cost differs from accounting cost because it includes opportunity cost.

As an example, consider the economic cost of attending college. The accounting cost of attending college includes tuition, room and board, books, food, and other incidental expenditures while there. The opportunity cost of college also includes the salary or wage that otherwise could be earned during the period. So for the two to four years an individual spends in school, the opportunity cost includes the money that one could have been making at the best possible job. The economic cost of college is the accounting cost plus the opportunity cost.

Thus, if attending college has a direct cost of $20,000 dollars a year for four years, and the lost wages from not working $25,000 dollars a year, then the total economic cost of going to college would be $180,000 dollars ($20,000 x 4 years + the interest of $20,000 for 4 years + $25,000 x 4 years).

Components of Economic Costs[edit]

    • Variable cost (TVC): Variable costs are the costs paid to the variable input. Inputs include labour, capital, materials, power and land and buildings. Variable inputs are inputs whose use vary with output. Conventionally the variable input is assumed to be labor.
    • Fixed cost (TFC) fixed costs are the costs of the fixed assets those that do not vary with production.
  • Average cost (AC) average cost are total costs divided by output. AC = TFC/q + TVC/q
    • Average fixed cost (AFC) = fixed costs divided by output. AFC = TFC/q. The average fixed cost function continuously declines as production increases.
    • Average variable cost (AVC) = variable costs divided by output. AVC =T VC/q. The average variable cost curve is typically U-shaped. It lies below the average cost curve and generally has the same shape - the vertical distance between the average cost curve and average variable cost curve equals average fixed costs. The curve normally starts to the right of the y axis because with zero production
  • Marginal cost (MC)
  • Cost curves