Types of Costs

Cost generally refers to the expenses incurred on inputs required for production of commodities- crops, live-stock etc. Inputs required are labour, seeds, manures and fertilizers, land, pesticides, diesel, electricity, irrigation water, feeds, fodders, medicines etc. Management of costs is very important to decide both the level of production and profit. There are two approaches to profit maximization:

1. Maximization of returns

2. Minimization of costs.

Various costs are considered in relation to production period – short or long.

1. Short Period: It is a period of time which is long enough to permit desired changes in output without altering or changing size of the plant or size of the farm and other infrastructural base of production. During a short period, it is not possible to change the size of the farm and output level can be changed only by manipulating some variable inputs such as manures, fertilizers, seeds, changing crops, changing labour force, etc.

2. Long Period: The long period is generally the period which is sufficiently long for output levels to be enchanged by varying all input factors including fixed factors like land, irrigation structure, buildings, machinery, etc. alongwith the variable inputs. For increasing production, size of farm can be enlarged, irrigation equipment can be purchased, tractor can be purchased and so on. On the basis of production period, costs are classified in two categories: (a) Fixed Costs, (b) Variable Costs.

1. Fixed Costs: The costs referred to fixed resource are fixed costs. Fixe resources means a resource which can be utilised in production process again and again as it does not get exhausted in one use. There are two types of fixed costs- (I) Cash and (ii) Non-cash. Land taxes, interest on fixed capital, insurance premia, annual hired labour are examples of fixed cash costs and depreciation on buildings, machinery equipment are the non-cash fixed costs. The fixed costs do not change with the level of output, they remain more or less same irrespective of level of production and hence the name fixed costs. Even of there is no production, these costs continue to occur.

2. Variable Costs: Variable costs refer to costs incurred on inputs, which are exhausted in one use in the production process eg. Cost of fertilizers, seeds, insecticides, fuel, daily wage labour, interest on working capital etc. These costs change with the levels of production. More the production higher the costs and vice versa. If there is no production, there are no variable costs.

Cost Function: Costs and production are functionally related. C=f(y). We understand what will happen to costs at different levels of production (see Table 1). On the basis of this relationship costs are classified as fixed costs, variable costs, total costs, average variable cost, average fixed cost, average total cost and marginal cost.

Total Costs: Total costs are the sum of variable cost and fixed cost. Total costs go on increasing as the level of production increases. This is due to increase in variable cost.

Average Variable Cost: This cost is arrived at by dividing the total variable cost by number of output units. Average variable cost is reduced initially due to increasing returns and increases in advance stage because of law of diminishing returns.

Average Fixed Cost: This cost is arrived at by dividing fixed cost by the number of output units. At initial stage it is quite high due to less production and later on decreases because of its distribution on more units of output. A producer has to bear fixed cost even if production is stopped.

Average Total Cost: This cost is arrived at by adding together average variable cost and average fixed cost. This cost gives idea about total expenses incurred for producing one unit of output. For finding out profit from total return it is necessary to know the total cost of production.

Marginal Cost: Marginal cost means cost incurred for producing additional unit of output. Initially marginal cost goes on diminishing due to economies of large-scale production. But in advance stage, it goes on increasing due to the operation of law of diminishing returns.

Profit Maximization:

Marginal Cost (MC) and Marginal Returns (MR) are the indicators to show at what level profit will be maximum. Profit will be maximum when marginal cost is equal to marginal return (MC=MR). In Table.2 it is seen that the profit is maximum at 290 units of output where marginal cost is almost equal to marginal returns. Total Returns are Rs. 2320 and Total Cost Rs. 1000, Leaving profit of Rs. 1320. At higher levels of output, marginal cost is more than marginal returns and hence profits declines.

NB- Total Returns are calculated at Rs. 8/- per output unit.

Classification of costs into two categories and estimating average cost or per unit cost helps in taking appropriate decisions. Since fixed costs are not much related to level of production, per unit fixed costs are more when production is small. Therefore, small farmers/small producers face the problem of high fixed costs. They should not make high capital investment in items, which are not likely to be used fully. A small farmer cannot afford to invest in a tractor, he cannot afford to employ labour on annual basis but only daily wage earner to be employed as and when required. Even maintaining a bullock pair is costly. A bullock pair has to be maintained even if it has only seasonal work for two-three months on small farms. Average or unit cost helps to understand the producer the cost of production of his produce and the price he receives in the market. Cost of his produce should be lesser than the price so that he can earn some profit. He can also manage his unit costs in relation to other farmers in the area to compete with them and stay in the farming business. Thus classification of fixed and variable and unit costs has great significant in farm management.

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(Farm Mgmt)