The Concept of Costs in Microeconomics - Term Paper Example

The Concept of Costs in Microeconomics Introduction The of costs in economics is a trivial concern because as simple as it looks, costs assume many forms and applications. As conventionally defined, cost means the amount of money paid for a certain product or service. According to Encyclopedia Britannica (par. 1), cost “in common usage, (is) the monetary value of goods and services that producers and consumers purchase.” What make the concept of cost challenging in microeconomics is the diverse types or classifications attached to it. Since microeconomics encompass the study of the behavior of individuals, firms, and industries in terms of producing and consuming of economic goods and services, the concept of cost is relevant as it affects microeconomic activities of the units concerned. For consumers and individuals who are not familiar with the concepts of costs, one might have the tendency to discard this as irrelevant and immaterial. However, close examination of these underlying theories would enlighten consumers on their effects on prices and quantities of goods which are normally offered to the public. It is therefore the objective of this essay to present relevant concepts, theories and applications concerning costs in microeconomics. The costs to be discussed range from opportunity cost, production costs, marginal cost, cost of externalities, the law of diminishing returns and economies of scale. Opportunity Cost It is interesting to note that in economics, all costs are considered opportunity costs. As rationalized by Petroff (par. 2), “anytime a resource is used for any purpose, it implies that some other good cannot be produced with that quantity of the resource, that some other resource is not used for the given production instead, and that revenues from other production are foregone. Thus, costs are either explicit cost for the resource used or implicit costs from alternative use of the resource.” To use a practical application, for a consumer who decided to buy a television set, the opportunity cost could be the value of a trip to a nearby beach resort which was not taken due to the purchase. Production Costs Productions costs are normally related to firms or business enterprises engaged in manufacturing or producing goods for sale to the public. The concept of productions costs are not only discussed in microeconomics but more so in accounting or finance. Production managers are tasked with monitoring the costs of raw materials as well as labor and overhead costs to maximize profits. These costs could be classified as fixed, variable and total costs. Petroff (par.19) defines total costs as “the sum of all costs: fixed and variable. The total cost curve is represented graphically as an up sloping curve: costs increase as output volume increases.” According to Encyclopedia Britannica, “total cost refers to the total expense incurred in reaching a particular level of output; if such total cost is divided by the quantity produced, average or unit cost is obtained.”(par. 2) Fixed costs, as the name implies, are not altered with changes in output or the quantity of products produced. An example of this cost is the cost of lease or rental of the office space. Variable costs, on the other hand, change depending on the amount or quantity of goods produced. Examples of these are raw materials and labor costs. Other concepts related to these are the measurement of average fixed, variable or total costs which simply divide the absolute amount with the quantity produced. Managers who have to operate within a budget utilize these concepts to adjust variable costs and other related inputs to minimize total cost and thereby increase profit for the firm. Marginal Cost Another cost concept which is of significance to economists, financial managers and accountants is marginal cost, or “the addition to the total cost resulting from the production of an additional unit of output. A firm desiring to maximize its profits will, in theory, determine its level of output by continuing production until the cost of the last additional unit produced (marginal cost) just equals the addition to revenue (marginal revenue) obtained from it.” (Encyclopedia Britannica par. 3) As mentioned earlier, production managers monitor marginal costs because of its implications to profits. Any diverse or drastic effect on income would necessitate a review of the components of inputs to determine which effective combination would maximize the profit potential of the entity. Cost of externalities Finally, not many know the concept of the cost of externalities, “that is, the costs that are imposed either intentionally or unintentionally on others. Thus the cost of generating electricity by burning high-sulfur bituminous coal can be measured not only by the cost of the coal and its transport to the power plant (among other economic considerations) but also by its cost in terms of air pollution.” (Encyclopedia Britannica par. 4) These are of extreme importance since enterprises all over the world are concerned of the effects of their by-products to the environment. With the emphasis given on environmental protection and the onset of global warming, companies measure the costs of externalities to prevent further destruction to the environment and pose a threat to life. Law of Diminishing Returns In relation to these cost concepts which are closely monitored mostly by firms engaged in production, Petroff (par. 12) deemed it necessary to discuss the law of diminishing returns, to wit: “the law of diminishing returns shows the observable occurrence that if variable inputs are increased beyond a certain point the incremental (or marginal) quantity produced (or returns) starts to decrease. Starting from a very low level of production, firms usually will benefit from increasing efficiency at first, but the gains dissipate and production becomes less efficient when the size capacity of the firms is over utilized.” This concept is readily identifiable and immediate correcting measures can be adopted to return the efficiency to the maximum level. By being aware of this concept, economists and managers can act immediately to save the firm from further losses due to over utilization of a fixed resource. Economies of Scale If the law of diminishing returns only occurs in the short run, economies of scale, on the other hand, occur in the long run. Petroff (par. 31) aver that “economies of scale result from gains in efficiency as the size of production is increased along with appropriate changes in fixed resources to utilize the available resources more fully.” The factors which enable the occurrence of economies of scale are: specialization in labor, intensive use of skilled labor and capital and the ability to innovate on the use of by-products. Firms which are able to apply this concept have developed an expertise in their field of endeavor and enabled them to utilize their resources to the fullest. Conclusion After a close evaluation and assessment of the concepts, theories and applications surrounding the costs in microeconomics, I came to realize that as future participants in business enterprises, the knowledge that is gained would be truly appreciated. As consumers, most individuals are not aware that there are so many cost concepts related to the product or service that they purchased or availed. We tend to immediately criticize increases of prices of commodities without any regard for the process with which the product came from. In these times of financial turmoil, we should be grateful that we were given the opportunity to understand important microeconomic concepts. It is through a realization that most of the goods we consume underwent a process where people have exerted so many efforts to ensure that these products conform to the needs of the customers. As consumers, before out rightly dismissing the products as they have served their original purpose, we can take time to savor all the inputs that were used to make that product an economic work of art. Outline: The Concept of Costs in Microeconomics Introduction Opportunity Cost Production Costs Marginal Cost Cost of Externalities Law of Diminishing Returns Economies of Scale Conclusion Works Cited "cost." Encyclopædia Britannica. 2009. Encyclopædia Britannica Online. 19 Apr. 2009 . Petroff, J. (2002). Microeconomics: A Review of Concepts. 19 Apr. 2009 < http://www.peoi.org/Courses/Coursesen/mic/fram3.html> Read More