Concept of Costs in terms of Traceability

1. Direct costs

Direct costs are related to a specific process or product. They are also called
traceable costs as we can directly trace them to a particular activity, product or
process.

They can vary with changes in the activity or product. Examples of direct costs
include manufacturing costs relating to production, customer acquisition costs
pertaining to sales, etc.

2. Indirect costs

Indirect costs, or untraceable costs, are those which do not directly relate to a
specific activity or component of the business. For example, an increase in
charges of electricity or taxes payable on income. Although we cannot trace
indirect costs, they are important because they affect overall profitability.

Fixed costs

Fixed costs are those which do not change with the volume of output. The
business incurs them regardless of their level of production. Examples of these
include payment of rent, taxes, interest on a loan, etc.

Variable costs

These costs will vary depending upon the output that the business generates. Less
production will cost fewer expenses, and vice versa, the business will pay more
when its production is greater. Expenses on the purchase of raw material and
payment of wages are examples of variable costs.

Opportunity costs

Opportunity costs are incomes from the next best alternative that is foregone
when the entrepreneur makes certain choices.

For example, the entrepreneur could have earned a salary had he worked for
others instead of spending time on his own business

Total Cost

In the short run, some of the factors are fixed, while other factors are variable. In
the same way, the short-run costs are also categorised into two different kinds of
cost; viz., Fixed Costs and Variable Costs. The sum total of these costs is equal to
the Total Cost.

I. Total Fixed Cost (TFC) or Fixed Cost (FC):

The costs on which the output level does not have a direct impact are known as
Fixed Costs. For example, salary of staff, rent on office premises, interest on loans,
etc. Other names of fixed costs are Supplementary Cost, Overhead Cost,
Unavoidable Cost, Indirect Cost, or General Cost. Fixed cost is the cost spent on
fixed factors such as land, building, machinery, etc. The amount spent on these
factors cannot be changed in the short run. Also, the payment made on these
factors remains the same whether the output is small, large, or zero.

Total Variable Cost (TVC) or Variable Cost :The costs on which the output level
has a direct impact are known as Variable Costs. For example, fuel, power,
payment for raw materials, etc. Other names of variable costs are Prime Cost,
Avoidable Cost, or Direct Cost. In other words, variable cost is the cost spent on
variable factors such as power, direct labour, raw material, etc. The amount spent
on these factors changes with the change in output level. Also, these costs arise
till there is production and become zero at zero output level.

Total Cost (TC):

The total expenditure incurred by an organisation on the factors of production

which are required for the production of a commodity is known as Total Cost. In
simple terms, total cost is the sum of total fixed cost and total variable cost at
different output levels.

TC = TFC + TVC

As the Total Fixed Cost remains the same at all output levels, the change in Total
Cost completely depends upon Total Variable Cost.

Average Cost

Average Costs are the per unit costs which explain the relationship between the
cost and output in a realistic manner. These per-unit costs are obtained from
Total Fixed Cost, Total Variable Cost, and Total Cost. The three different types of
per-unit costs are as follows:

Marginal Cost

The additional cost incurred to the total cost when one more unit of output is
produced is known as Marginal Cost. For example, if the total cost of producing 2
units is ₹400 and the total cost of producing 3 units is ₹600, then the marginal
cost will be 600 – 400 = ₹200.

MCn = TCn – TCn-1

Where,

n = Number of units produced

MCn = Marginal cost of the nth unit

TCn = Total cost of n units

TCn-1 = Total cost of (n-1) units

Another way to calculate Marginal Cost:

When the change in the units produced is more than one unit, then the previous
formula of calculating MC will not work. In that case, the formula for calculating
Marginal Cost will be:

MC= Change in units of Output

Change in Total Cost

For example, if the total cost of producing 5 units is ₹700 and the total cost of
producing 3 units is ₹250, then the marginal cost will be:

MC= 700−250 (5 UNITS -2 UNITS)

450/2 UNITS

Marginal Cost = ₹225

In economics, demand is the quantity of a good or service that a consumer is

willing and able to purchase at different price levels available during a given time
period. Although the demand is the desire of a consumer to purchase a
commodity, it is not the same as desire. Desire is just a wish of a consumer to
purchase a commodity even though he is unable to buy it. However, demand is a
consumer’s desire to purchase a commodity, provided he is willing to spend and
has sufficient purchasing power.

Hence, we can say that the four essential elements of demand are:

Quantity of the commodity

Willingness of a consumer to purchase the commodity

Time period

Price of the commodity at each quantity level

Determinants of Demand

[Link] of the given commodity: The most important factor affecting the demand
for a commodity is its price. In general, there is an inverse relationship between
the demand and price of a commodity. If the price of a commodity decreases, the
quantity demanded will increase, as more people will be willing and able to
purchase the commodity. However, if the price of a commodity increases, its
demand will decrease because of the fall in consumers’ satisfaction levels. For
example, if the price of coffee decreases, people who were not able to afford
coffee in the past can now purchase and hence will increase its demand.

[Link] of the related goods: The demand for a commodity also depends on the
change in the price of the related goods. There are two types of related goods:
Substitute goods and Complementary goods.

Substitute Goods: The goods which can be used by a consumer in place of one
another to satisfy a particular want are known as substitute goods. If the price
of a substitute good increases, then the demand for the given commodity will
also increase, and vice-versa. For example, a decrease in the price of a
substitute good, tea, will reduce the demand for the given commodity, say
coffee.

Complementary Goods: The goods which are used together by a consumer to

satisfy a specific want are known as complementary goods. If the price of a
complementary good increases, the demand for the given commodity will
decrease as they are consumed together by the consumer. For example, a
decrease in the price of a complementary good, sugar, will increase the
demand for the given commodity (say tea) as the cost of using both products
together will be relatively less.

[Link] of the consumer: The demand for a commodity also changes with a
change in consumer income. However, the effect of income on the demand of a
commodity depends on its nature. There are two types of goods: normal and
inferior.

Normal Goods: These are the goods whose demand increases with the
increase in consumer’s income. For example, if a consumer’s income rises, he
will buy more of the normal goods.

Inferior Goods: These are the goods whose demand decreases with the
increase in consumer income. For example, if the income of a consumer
increases, he will no more purchase the inferior goods, hence, decreasing its
demand.

[Link] of change in the price of a commodity in the future: If the

consumer expects that the price of a commodity will increase in the near
future, its demand at present will also increase. Hence, there is a direct
relationship between a commodity’s expectation of a change in its price in the
future and the change in the commodity’s demand at present. . For example, if
a consumer expects that the price of petrol will decrease in the future, he will
not fill his vehicle’s petrol tank at present.

[Link] and preferences: A consumer’s tastes and preferences for a

commodity directly influence his/her demand for that commodity. The tastes
and preferences of a consumer include customs, tradition, religion, habit,
fashion, etc. For example, if an item of clothing is in trend or fashion, people
will be more likely to purchase that particular clothing, increasing its demand.

[Link] and weather: The seasonal and weather conditions of a region

greatly impact the demand for a commodity. For example, in places like
Himachal, the demand for warm clothes is high as compared to summer
clothes.
[Link] of income: The demand for commodities will be high in
countries with equitably distributed income. However, the demand for
commodities will be low if there is uneven income distribution in a country.
Uneven income distribution means either people living in that country are
very rich or very poor.

[Link] and composition of population: The size of a country’s population

highly affects a commodity’s market demand. If the population of a country
increases, the market demand will also increase and vice-versa. Besides the
number of people living in a country, their composition (such as male-female
ratio, older people, youngsters, children, adults, etc.) also affects the market
demand. For example, if a country has a large proportion of children, then the
market demand for goods like toys, ice cream, chocolates, etc., will be more.