The costs of production

A business needs accurate and reliable cost information to make decisions. A firm that is aiming to expand production to meet rising demand must know how much that extra production will cost. Without this information it will have no way of knowing whether or not it will make a profit.

Economists usually think of costs as opportunity costs. The opportunity cost is the value that could have been earned if a resource was employed in its next best use. A business is also concerned, however, with Accounting Costs. An accounting cost is the value of a resource used up in production. This is shown in the business accounts as an asset or an expense. For example, if a firm buys some fuel costing 5,000, this is shown as an expense in the accounts.

It is also important to understand how a firm’s costs change in the Short Run and the Long Run.

  • Short run is the period of time when at least one factor of production is fixed. For example, in the short run, a firm might want to expand production in its factory. It can acquire more labour and buy more raw materials, but it has a fixed amount of space in the factory and a limited number of machines.
  • In the long run, all factors can vary. The firm can buy another factory and add to the number of machines. This will increase capacity.