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In economics, business, and accounting, a cost is a price paid, or otherwise associated with, a commercial event or economic transaction.

Costs are often further described based on their timing or their applicability.


Accounting vs opportunity costs

Accounting costs (also called historical costs) represent the total amount of money (or the monetary value of goods) spent. It is the amount denoted on invoices and recorded in bookkeeping records.

Opportunity cost (also called "economic cost") is the value of the best alternative that was not chosen in order to pursue the current endeavour--i.e., what could have been accomplished with the resources expended in the undertaking. It represents opportunities forgone.

If a person has a job offer that pays $25 for an hour's work, and instead chooses to take a nap, than the accounting cost of the nap is zero; the person did not hand over any money in order to nap. However, the opportunity cost is the $25 that could have been earned working.

In theoretical economics, cost used without qualification often means opportunity cost.

Sunk vs incremental costs

Sunk costs are costs that have already been incurred and which cannot be recovered to any significant degree. Incremental cost s are the costs that will change as a result of the proposed course of action. In microeconomic theory, only incremental cost are relevant to a decision. See sunk cost for a detailed discussion.

Private vs external vs social vs psychic costs

When a transaction takes place, it typically involves both private costs and external costs. Its private costs are the costs that the buyer of a good or service pays the seller. Its external costs (also called externalities), in contrast, are the costs that people other than the buyer are forced to pay as a result of the transaction. The bearers of such costs can be either particular individuals or society at large. Note that external costs are often both non-monetary and problematic to quantify for comparison with monitary values. They include things like pollution, things that society will likely have to pay for in some way or at some time in the future, but that are not included in transaction prices.

Social costs are the sum of private costs and external costs, that is, both the costs internal to the firm's production function and external costs not included in the firm's production function.

For example, the purchase price of a car reflects the private cost experienced by the manufacturer. The air pollution created in the production of the car however, is an external cost. Because the manufacturer does not pay for these costs, and does not include them in the price of the car, they are said to be external to the market pricing mechanism. The air pollution from driving the car is also an externality. The driver does not pay for the environmental damage caused by using the car.

A psychic cost is a subset of social costs that specifically represent the costs of added stress or losses to quality of life.

See also

Last updated: 02-07-2005 07:07:03
Last updated: 02-11-2005 17:47:38