Cost of production incurred includes several factors like rent, salaries and allowances, depreciation, interest on capital, rent for land etc. The costs are divided into three types, namely money costs, real costs and opportunity costs.
Money costs :
Money costs are also known as nominal costs and normal costs. They refer to the money payments made by a producer for producing goods. Money costs are further divided into two types namely Explicit costs and Implicit costs. Costs actually paid out by the producer are known as explicit costs. Costs paid for the services of the entrepreneur and for his own factors are known as implicit costs. Implicit costs include
- a) Wages for the services of management and supervision by the entrepreneur
- b) remuneration to the factors owned by the entrepreneur,
- c) Interest to the capital,
- d) Normal profits accrued to the entrepreneur.
Money costs include both the explicit and implicit costs. The producer earn profits when the revenue is more than the money costs. Money costs are important in production because they are the basis for price determination. In the long run the producer continues production until the profit is equal to money costs.
Real Costs :
According to Prof. Marshall, real costs are those social costs which measure the extension of different kinds of labor that are directly or indirectly involved in production together with the abstinence or rather than waiting required for saving the capital used in making it. All those efforts and sacrifices together will be called the real cost of production of that commodity. So real costs are subjective in nature. The classical economists considered that real costs indicate the efforts, sacrifices and dis-utilities involved in producing a commodity. We can’t measure the real costs as we can’t measure the pains, sufferings, efforts and sacrifices of all the persons concerned in production.
Criticism of Real Costs:
The concept of real costs is criticized on the following grounds:
1 ) As real costs include efforts, troubles and sacrifices which are psychological, they can’t be measured.
2) It is difficult to pay remuneration to the factors of production on the basis of real costs. In fact remuneration for them are paid according to their demand and supply.
3) As land is a free gift of nature, it involves no real costs.
4) It is difficult to compare the efforts and sacrifices of the persons working in different spheres of production.
5) If real costs are the basis for payment of remuneration, the persons working in coal mines and factories get more wages than an engineer working in a project or an office manager. But this principle is not followed in actual practice.
6) Savings has to be made by reducing the consumption expenditure. So the concept of real costs indicates that interest paid for the savings must be equal to the sacrifice made by individuals. But we don’t observe any sacrifice in the savings of rich people. But they are getting interest for their savings.
Due to the difficulties involved in the measurement, the modern economists have discarded the concept of real costs. However, the concept is useful for understanding the pains and sufferings of laborers in production.