Distinguish Between Money Cost And Real Cost

Distinguish Between Money Cost And Real Cost Theory
Distinguish Between Money Cost And Real Cost Worksheet
Difference Between Costs And Expenses

Measuring Costs: There are several ways to measure costs. Most often, we think of 'cost' as the amount of money to be paid for a good or service. The money cost is similar to the economic concept.
Knowing the difference between average cost and total cost can help a company determine prices and when it's time to expand. In case you were curious, this lesson explains both.
Money cost is the cost of acquiring a product or service in available cash. Real cost is the cost of the same expressed in other intangible factors, in addition to cash, such as time, labor, lost opportunity, etc.

The classification of cost into money and real cost has been given by Marshall.

Marshall made a distinction between the cost of production and the expenses (expenditures) of production by saying that, “All the efforts and sacrifices made by the producer is the real cost of production while the money paid to other factors of production for these efforts is termed as the expenses of production”.

Money Cost:

When production cost is expressed in terms of monetary units, it is called money cost. It means the aggregate money expenditure incurred by a producer on the purchase, procurement and processing of inputs.

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Money cost is widely used in the theory of production. While the production function considers technical relationship between physical inputs and output, the cost analysis basically deals with the monetary aspect of these relationships. This cost includes not only sacrificed alternative, but also monetary payments. It is the sum of explicit and implicit cost.

Real Cost:

Alfred Marshall calls real cost of production as a ‘social cost’. Real cost refers to the payments made to the factors of production to compensate for disutility’s of rendering their services. It is computed in terms of the toil, trouble, pain and discomfort involved for labour, when it is engaged in production.

Similarly, the abstinence, pain and sacrifice involved in saving and capital accumulation is the real cost of capital. In the words of Marshall,

“the exertions of all the different kinds of labour that are directly or indirectly involved in making it together with abstinence or rather the waiting required, for saving the capital used in making it, all these sacrifices together will be called the real cost of production of a commodity”.

All works do not involve same level of real cost. Some works are more unpleasant, irksome and painstaking and therefore, involve more real sacrifice. Similarly, a work in which the health of the workers is adversely affected involves more real cost.

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The concept of real cost, though important from social point of view, lacks precision due to subjectiveness involved. It cannot be subjected to accurate monetary measurement. In reality, real costs seldom equal money expenses of production. The real costs can also be measured at constant prices, i.e., by adjusting money cost for rise in the prices.

Cost of Production: Money, Real and Opportunity Costs!

The concept of cost of production is very significant in economics because it influences the production, supply, sales and the determination of price in the market.

It means cost of production is a function of total costs in relation to price to guide the firm in deciding whether to expand or contract output and also whether to leave or enter an industry.

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The concept of real cost, though of some importance from the social point of view, lacks precision since it is expressed in subjective terms. Watson uses the term ‘cost function’ to denote the general relation between output and cost. It tells that change in output effectively leads to change in cost of production.

According to Prof. Watson, cost function can be expressed as:

C= f (q)

Where:

C = Cost of Production

q = output

f= functional relationship

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However, Prof. Koutsoyiannis states “cost functions are derived functions. They are derived from the production function.”

For easy and clear understanding, cost of production can be illustrated as:

1. Money Costs:

Money cost is also known as the nominal cost. It is nothing but the expenses incurred by a firm to produce a commodity. For instance, the cost of producing 200 chairs is Rs. 10000, and then it will be called the money cost of producing 200 chairs.

Therefore, money costs include the following expenses:

(i) Depreciation and obsolescence charges.

(ii) Power fuel charges.

(iii) Wages and salaries.

(iv) Cost of machinery, raw material etc.

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(v) Expenses on advertising and publicity,

(vi) Interest on capital.

(vii) Expenses on electricity.

(viii) Insurance charges.

(ix) Transport costs.

(x) Packing charges.

(xi) All types of taxes viz; property tax, license fees, excise duty.

(xii) Rent on land.

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Therefore, money costs relate to money outlays by a firm on factors of production which enable the firm to produce and sell a product. Every producer is interested only in nominal costs. Thus, in the words of Prof. Hanson, “The money cost of producing a certain output of a commodity is the sum of all the payments to the factors of production engaged in the production of that commodity.”

Moreover, total costs of a firm include both:

(i) Explicit as well as

(ii) Implicit costs.

(a) Explicit Costs:

Explicit costs refer to all those expenses made by a firm to buy goods directly. They include, payments for raw material, taxes and depreciation charges, transportation, power, high fuel, advertising and so on.

According to Leftwitch, “Explicit costs are those cash payments which firms make to outsiders for their services and goods.” He has given stress on the word explicit and it may be called the approach used by the accountant of the firm. The payments are explicit-clear-cut, paid to agents (owners) of factors of production. A contract fixes the rate at which the payments are to be made.

The examples are clear to see. These are wages to workers, money paid for raw materials and semi-finished goods, various fixed costs etc. The producer takes money out of his pocket and pays to others. These are payments to attract resources from other uses to the use made by a particular producer. They are also known as Accounting Costs or Historical Costs.

(b) Implicit Costs:

Implicit costs are the imputed value of the entrepreneur’s own resources and Services. In fact, these costs refer to the implied or unnoticed costs. They include the interest on his own capital, rent on his land, wages of his own labour etc. Moreover, these costs go to the entrepreneur himself and are not recorded in practice. In the words of Leftwitch, “Implicit costs are the costs of self-owned, self employed resources.”

In short we can say that:

Economic costs = Explicit costs – Implicit costs

There are some resources which are “self-owned” and are self- employed”; the cost is in the shape of income given up rather than payment made. The income forgone is income which could have been earned by allowing the resources to be used by somebody else and the ‘cost’ is at the rate at which income could be earned in the next best use.

Suppose a producer uses his own money in his own business. He does not pay any interest to himself, but he could have earned some money if he had given the money as loan to someone else. Thus for personal capital, self-employed rate of interest would be imputed at the rate at which it could earn interest somewhere else. To make the approach still more realistic, the modern economists prefer to add normal profit to imp

Distinguish Between Money Cost And Real Cost