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The cost of production is a catch-all word for the average cost produced during the manufacturing process. In economics, the inputs to the manufacturing process are referred to as factors of production, which aid in the operation of the business. The supply of money, labor, and land are all key factors that affect the firm's output. In economics, these properties are divided into two types: financial capital and physical capital. Before engaging in a business concept, companies consider the determinants of the goods or services they sell, retail prices and distribution costs for these products and services, the volumes to be manufactured, and the technology to be used. The consideration for such necessities allows flexibility in the production process since the firm is able to channel resources in more productive and higher return sections while sustaining the operations of the entire firm.
The economic theory suggests that the implementation of a successful business venture considers these questions as dependent on each other. For example, the determination of the market prices at which a product will be sold needs to consider the relative costs of labor, capital, and other production factors which in turn depends on the technologies in use. Based on the firm theory, the distinction between the long run and the short run costs is based on the variation of inputs that the firm can achieve. While the long run costs influencing the production process are variable, the short run costs are fixed. The technology that a firm uses is also dependent on the market trends and the levels of production that the firm attains. This collectively forms the basis for determining product pricing. The key to developing clear strategies to facilitate production at all possible levels is to establish the relationship between the outputs and the cost of inputs into the process, a relation often referred to as cost function by economists. It is important to establish the properties of the cost functions in differentiating between the accounting cost and the economic cost; between the fixed, variable, and sunk cost; and between the short run and the long run costs. The distinction between the economic cost and the accounting is that the former is based on the concept of forward looking, while the latter is based on the concept of record keeping or backward looking. The variations between the variable, fixed, sunk, long run, and short run costs are dependent on the market patterns. The firm loses the opportunity to utilize an asset in other areas once it has been lined on the production line. The best alternative is the application of the foregone profits, which are equal to the opportunity cost.
The value for the economic cost is the difference between the opportunity cost and the sunk cost. Firms deal with variable and fixed costs of assets of which fixed costs arise from acquiring fixed inputs. Variables costs similarly are derived from variable inputs. Only variable inputs can be altered by increasing or decreasing the production rates. Costs associated with purchasing fixed assets become essential only when the firm is to engage in production processes. The neoclassical theory is based on the assumption that producers will decline to market for their products with rising marginal costs up to the equilibrium condition since such costs do not cover the marginal capital invested in the production of goods.
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