Cost

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In economics, business, and accounting, a cost is the value of inputs that have been used up to produce something, and hence are not available for use anymore. In business, the cost may be one of acquisition, in which case the amount of money expended to acquire it is counted as cost. In this case, money is the input that is gone in order to acquire the thing. This acquisition cost may be the sum of the cost of production as incurred by the original producer, and further costs of transaction as incurred by the acquirer over and above the price paid to the producer. Usually, the price also includes a mark-up for profit over the cost of production.

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

Contents 1 Accounting vs opportunity costs 2 Comparing Private, external, social and psychic costs 3 Cost estimates and cost overrun 4 Associated cost 5 References 6 Path Cost 7 See also

Accounting vs opportunity costs

Historical costs or accounting 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 referred to as 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, then 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.

Comparing Private, external, social and psychic costs

When a transaction takes place, it typically involves both private costs and external costs.

Private costs are the costs that the buyer of a good or service pays the seller. This can also be described as the costs internal to the firm's production function.

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 monetary 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.

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.

Cost estimates and cost overrun

When developing a business plan for a new company, product, or project, planners typically make cost estimates in order to assess whether revenues/benefits will cover costs (see cost-benefit analysis). This is done in both business and government. Costs are often underestimated resulting in cost overrun during implementation. Main causes of cost underestimation and overrun are optimism bias and strategic misrepresentation (Flyvbjerg et al. 2002). Reference class forecasting was developed to curb optimism bias and strategic misrepresentation and arrive at more accurate cost estimates.

Cost Plus, is where the Price = Cost plus or minus X%, where x is the percentage of built in overhead or profit margin.

Associated cost

Associated costs are always enormously overestimated, often by an order of magnitude.

References

• William Baumol (1968), Entrepreneurship in Economic Theory. American Economic Review, Papers and Proceedings.
• Ronald Coase (1988), The Theory of the Firm.
• Bent Flyvbjerg, Mette K. Skamris Holm, and Søren L. Buhl (2002), "Underestimating Costs in Public Works Projects: Error or Lie?" Journal of the American Planning Association, vol. 68, no. 3, 279-295.
• Israel Kirzner (1979), Perception, Opportunity and Profit, Chicago: University of Chicago Press.

Path Cost

Also seen as a term in networking to define the worthiness of a path.

See also

average cost accounting costs Cost accounting cost-benefit analysis Cost curve cost overrun Cost underestimation

external cost fixed costs historical cost incremental costs life cycle costs list of economics topics list of accounting topics Long run average cost marginal cost

opportunity costs parametric estimating - a cost estimating methodology price private costs production, costs, and pricing psychic costs social costs sunk costs total cost transaction costs variable costs

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