Production costs are a group of expenses, as well as financial costs, required in order to create a product. When, as a result of the sale of goods, the manufacturer receives money, then a certain amount must go to compensation, while the other part becomes profit.
What is Opportunity Cost of Production
The main part of production costs is the use of a certain list of resources for the production of goods. It should be understood that resources used in one place cannot be used in another. For example, money spent on a pizza oven cannot be spent on pizza products. This kind of resource has properties such as scarcity and scarcity.
Roughly speaking, if one resource begins to be used in a certain area, then it simply loses the opportunity to be used in some other area of activity.
Hence the conclusion that at the beginning of the production of certain products, a complete rejection of the use of the same resources in another area of activity is required.
It is these resources that are commonly referred to as "opportunity costs of production." It is important to take them into account when analyzing any work.
Opportunity production costs are usually called any costs of manufacturing a specific product, which can be estimated from the point of view of the lost possibility of their application in another area and for another purpose.
Also, the opportunity costs of production can be called:
- The cost of a missed opportunity to produce goods and services.
- Imputed costs.
- By the expense of denied opportunities.
What is usually included in the opportunity cost of production
Opportunity costs of production are usually measured in monetary terms. They are determined by the difference between the profit that the organization could receive with the most rational use of available funds and the actual income received.
But there are also costs that cannot be called opportunity costs. The costs that are made by the enterprise in the order of absolute can not be called alternative. Such expenses include renting premises, paying taxes, and so on. When making decisions of an economic nature, such costs are not analyzed.
What are implicit production costs?
It is customary to call the implicit costs of rejected opportunities only those costs of production that are owned by the organization. Implicit costs are not eligible costs.
Such costs can be defined by the following concepts:
- Profit, defined by an entrepreneur as the minimum remuneration that can force him to stay in a particular field of activity. Example. The man is engaged in the sale of rabbit meat. And he believes that a profit of 16% of the amount he invested in the production process is normal. But if, as a result of production, the constant profit is slightly lower, then he will have to transfer his capital to a new sphere in order to receive later the profit normal in his opinion.
- The finances that a person could receive if he used the resources available on the balance sheet in another, more profitable area. This includes the salary that a person could receive by working in another area for hire.
- For the costs of implicit production, there is a law, the essence of which is that the profit that the owner could receive by defining his capital for another task can also act as a cost for the owner. For example, a person who has land at his disposal may have such implicit opportunity costs as rent, provided that he did not use the land on his own, but leased it.
Based on Western economic theory, it turns out that the opportunity costs of production include the entrepreneur's income, considered as payment for risks. At the same time, this fee is a reward, and also an incentive to keep your assets in the form of finance in the current enterprise, without redirecting them to another production process.
What are explicit production costs
It is customary to call explicit alternative production costs the money that was paid to suppliers for the provision of the necessary factors of production that are required to organize the process as a whole and its intermediate stages.
In particular, it is customary to note the following explicit production costs:
- The costs of any shipping costs.
- Payments required to buy or rent a building, machinery, machine tools, structures and other equipment necessary to create a product.
- Wages to workers involved in the production process.
- Communal payments.
- Payments for purchasing resources from suppliers.
- Payments to banks and insurance companies for the provision of their services.
How economic costs differ from accounting costs
Those costs in production, which, among other things, consist of average or normal profit, are called various economic costs. Such costs are temporary and, based on modern economic theory, are considered those costs that are realized subject to the choice of the most profitable economic decision. Thus, it turns out that this is exactly the trait that any entrepreneur must strive for. But as a result of the fact that such an ideal is difficult to obtain in modern practice, the real picture of total production costs looks somewhat different.
It is important to understand that economic costs are not accounting costs. For any operations in accounting, such an indicator as the curve of production capabilities is used.
In economic theory, opportunity costs of production are used, which differ from accounting in the ability to estimate internal costs.
For a more illustrative example, consider the production of grain. A part of the crop should be retained by the grower in order to sow the plantation later. Thus, it turns out that the grain produced by the enterprise will be used by it for its own internal needs. And this amount of grain is not paid.
When accounting, internal costs must be accounted for at cost. But, if we evaluate the received goods from the side of pricing, then this grain or other similar opportunity costs of production should be estimated at market value.
What are external and internal production costs
In order for an entrepreneur to receive full-fledged data and to be able to fully calculate, as well as to maximize production activities, it is necessary to consider production capabilities from all angles. Both external and internal opportunity costs of production are taken into account.
External funds include those funds that must be spent to purchase resources owned by third parties. Providers of the necessary resources will treat this money as revenue.
Internal costs are the enterprise's own resources that do not need to be purchased from other enterprises. Of course, the entrepreneur himself does not pay money for them, but he must take it into account. Otherwise, it will be impossible to accurately calculate whether his activity is profitable, or whether he is at a loss.
There is also a third type of cost - average. It was Karl Marx who built the concept of the production price and the rate of profit, which will subsequently fall on capital. This type of production costs also takes place in accounting, but here the main role is given to marginal and total costs.
An entrepreneur, whose main goal should be to make a profit, should be important not only the total costs of production, but also the average costs. The latter type of costs is used for comparison with the cost, which must be indicated for each item and each unit of goods.
Knowing the opportunity cost of production helps to determine whether production is profitable or it makes no sense to delay it. If the average income received as a result of selling one's own goods is at least slightly less than the average production costs, then the entrepreneur can minimize his losses by closing the enterprise as soon as possible.
