There are three important concepts regarding cost of production. They are:
- Real cost
- Opportunity cost and
- Monetary cost.
1. Real cost:
- According to Marshall, the labourers, capitalists and entrepreneurs who are involved in the process of production bear psychological and physical burden. Such burden is called real cost.
- Money spent by producers for production work of goods is not the only cost of production. Mental factors such as fatigue, boredom tension, stress faced by the labourers, the anxiety faced by entrepreneur or investors who risk their saving and capital, insecurity of wrong decisions, etc. are also the factors included in the real cost.
- Owing to the monetary as well as various other factors, real cost cannot be actually measured in monetary terms. Hence, real cost is also called non-monetary cost.
- As per Marshall, the factors of production have to bear this real cost. So, to attract these factors return is given in the form of wage, interest and profit.
Problems in measuring real cost:
- As per the concept of real cost psychological factors such as fatigue, boredom, pain, sacrifice and anxiety are a part of production of goods. It is quite
difficult to measure the real cost of goods which face these psychological factors during production.
- Moreover, other factors such as the smoke emitted by factories, the polluted water released in rivers, streams, etc. create adverse effect on health of the people of surrounding area. From the perspective of society this adverse effect is also a cost which cannot be measured.
2. Opportunity cost:
- The concept of opportunity cost was presented by Austrian economist but it was properly presented by Marshall. We know that the means of production have alternative uses i.e. more than one use. The concept of opportunity cost is based on the particular characteristic of factor of production which says that when a factor is used for a particular use, the other use is left out or the same cannot be used for other purpose. Under such circumstances, the best alternative which remains is the opportunity cost of production.
- If a factor of production is used in the production of one commodity which seems the best, the next best or say the second best alternative is left out.
- Assuming the best choice is made, opportunity cost is the ‘cost’ incurred by not enjoying the benefit that would have been had by taking the second best available choice
Example:
(a) If someone is producing wheat on one piece of land, then at the same time on the same piece of land other food grain (crop) cannot be produced.
(b) A worker working in textile mill cannot at the same time work in any other industry.
- Suppose if wheat is produced on a piece of land one can earn an income of ₹ 2 lakh can be earned and if rice is produced the income of ₹ 3.5 lakh can be earned.
- The farmer decides produce rice in which he earns more.
- So, to get the income of ₹ 3.5 lakh from the production of rice, farmer loses out income of ₹ 2 lakh from the production of wheat. This left out income of ₹ 2 lakh from the production of wheat is called the opportunity cost of ₹ 3.5 lakh earned from the production of rice.
Problems in measuring opportunity cost:
(I) Factors with one use:
If a factor of production has only one use then its opportunity cost cannot be decided.
Example:
(a) Suppose if a piece of land is used only to produce grass so far than we cannot calculate the opportunity cost of that land.
(b) The same applies for a person who is currently unemployed. Since the person does not have any work how can we calculate alternative cost?
(II) Factors having specific use:
If factors of production have only a specific use then the concept of opportunity cost is not useful. Returns of these factors are not decided by their alternative uses but on the basis of their demand.
Example:
(a) Persons having expertise over computers, scientist having knowledge of atomic power, etc. These people do not know any other work except their own.
(b) Machine for making ice can only produce ice i.e. it has no alternative use and so no opportunity cost is involved.
3. Monetary cost:
Generally, the amount that the producer pays monetarily for the process of production is called its monetary cost. Thus, the cost of production in terms of money is known as monetary cost. Monetary cost includes wages, rent, raw material, fuel and the total of all the expenditure made by the producer.
Example:
- If a factory producing pens incur the cost of ₹ 50,000 to produce 1000 units of pen, the monetary cost to produce 1,000 units of pen is ₹ 50,000.
- Real cost and opportunity cost have many limitations which make their calculation very difficult. Hence, the concept of monetary cost is widely used in economic analysis, for decisions related to production and in price determination. Since cost of production is calculated in terms of money, the concept of monetary cost is important.
