1. Various Type of Costs
• There are different type of costs and can be
classified by various ways
• This lecture includes costs classifications
mostly use by economists
• Fixed & Variable Costs, Average Costs & Marginal
Costs, Private & Social Costs
• Opportunity Costs
• Some other important cost concept you may
come across: Sunk Cost and Sinking funds,
Operation & Maintenance Cost (O&M Costs),
Life-cycle Costs etc.
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Fixed and Variable Costs
• Fixed Costs: those costs that do not vary with the
quantity of output produced.…any example ?
Examples: rent to paid for factory building, interest on
invested capital, maintenance, taxes etc
• Variable Costs: are those costs that do vary with the
quantity of output produced
Examples: consumption of fuel for power generation ….it
will vary as the production of a factor increases or decrease
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2. Total Costs
• It maybe noted that Fixed Costs (FC) and
Variable Costs(VC) may consist of more than
one component and the sum of all respective
components will make up TFC and TVC
respectively
• Total Costs (TC) is equal to sum of Total Fixed
Costs (TFC) and Total variable costs (TVC):
TC = TFC + TVC
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Average Costs
• Average Costs
– Average costs can be determined by dividing the
firm’s costs by the quantity of output it produces
– The average cost is the cost of each typical unit of
product
• Average Costs can also be obtained by adding
Average Fixed Costs (AFC) and Average Variable
Costs (AVC) …i.e: ATC = AFC + AVC
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3. Average Costs
Example: a firm produce 100 units of output at cost of
$1000, what is the average cost of the firm?
AFC 
AVC 
Fixed cost FC

Quantity
Q
Variable cost VC

Quantity
Q
ATC 
Total cost
Quantity
TC

Q
= 1000/100 => $10
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Marginal Costs
• Marginal Cost
– Marginal cost (MC) measures the increase in
total cost that arises from an extra unit of
production
– Marginal cost helps answer the following
question:
• How much does it cost to produce an additional unit of
output?
MC 
(change in total cost) TC

(change in quantity)
Q
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4. Private / Social Cost
• Private costs (benefits) of an action
– accruing to the actor only
• Social costs (benefits)
– total costs of activity including those that accrue
to people other than the actor
• Example: driving a car
– Private costs: fuel, maintenance
– Social costs include pollution, road wear
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Opportunity Costs
I got a lottery of
worth Rs 10 millions
(1 core)
Ranking the Choices
1
2
3
The Next best use is “buying house” that’s I
forgone for paying my Credit card debts so that’s
my Opportunity cost
Opportunity Cost:
The Next Best Decision you could make
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5. Opportunity Costs
• Opportunity cost is the cost of second
best use of the available/used
resources in a certain action
• The opportunity cost of you people
sitting in this class is …the next best
use of your this time … in work,
recreational activities, sports or
facebooking 
• My opportunity cost of teaching you
this Course is …… the time & earning
opportunity I forgone to teach you
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Sunk Cost
• Sunk Cost: is the costs that
are incurred in the past
and can not be recovered
by any future action
• Theory states: ignore sunk costs, because they are
paid in either case, and cannot be recovered
• For example: If you lost the movie ticket worth Rs. 800 - you
can't get it back - if you decide not to buy a second ticket and go
home you won't get the first ticket you lost, back
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6. Sinking fund
• A sinking fund is a fund established by
an economic entity by setting aside revenue
over a period of time to fund a future capital
expense, or repayment of a long-term debt
• Sinking funds can also be used to set aside
money for purposes of replacing capital
equipment as it becomes obsolete, or major
maintenance or renewal of elements of a fixed
asset, typically a building
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Operation and Maintenance Cost
(O&M Costs)
• Operation and Maintenance Cost is the group of costs
experienced continually over the useful life of the
activity… any example ?
• This includes costs like, labour costs for operating &
maintenance personal, fuel and power costs, spare
and repair part costs, costs for taxes etc.
• These costs can be substantial and can exceed the initial
costs
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7. Life-cycle Costs
• Life-cycle - all the time from the initial
conception of an idea to the death of a
product (process)
• Life-cycle costs - sum total of all the costs
incurred during the life cycle
• Life-cycle costing - designing a product with
an understanding of all the costs associated
with a product during it’s life-cycle
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Product Life-cycle
Begin
Needs
assessment
and
justification
Time
Conceptual or
preliminary
design phase
Impact Analysis
Requirements
Overall
Feasibility
Conceptual
Design
Planning
Proof of
concept
Prototype
Development
and testing
Detailed design
planning
Detailed
design
phase
Allocation of
resources
Detailed
specification
Component
and supplier
selection
Production or
construction
phase
Production or
Construction
Phase
Product,
goods and
service
built
All
supporting
facilities
built
Operation
al use
planning
End
Operational
Phase
Decline and
retirement
phase
Operational Use
Use by ultimate
customer
Maintenance and
support
Process,
materials and
methods use
Declined and
retirement
planning
Decaling
Use
Phase out
Retirement
Responsible
disposal
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8. Cumulative Life-cycle Costs
Committed and Dollars Spent
Total life-cycle cost %
100%
Life-cycle costs committed
80%
60%
Life-cycle costs spent
40%
20%
0%
Definition and
conceptual design
Detailed
design
Production
Operational use
Decline/
Retirement
Project Phase
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