Cost of Production

The concept of cost most widely used in economics is the one relating to the ‘money cost of production.’ The ‘money cost’ refers to the total amount of money spent upon the production of a given quantity of output. This includes the money spent upon wages and salaries, the expenditure on the purchase of materials, fuel and power, insurance and transport expenditure and all the other expenses incurred in connection with the production of the given level of output. The total amount of money spent on purchasing or hiring factor inputs, such as land, labour, capital, intermediate goods, and services of managers and organizers, is called cost of production.

Symbolically, if labour and capital are the only two factor inputs, then

TC (Q_X) = L.P_L + K.P_K

Where Q_X is the quantity of good X produced, and L and K are the quantities of the two factor inputs, viz. labour and capital used. Since we have to purchase or hire each input, we have to pay a price for its use, which is called hire price per unit or simply price per unit of input. Thus, wage rate is the hire price of labour, interest is the hire price per unit of capital. if we denote the hire prices of each factor input respectively by P_L and P_K, the above equation shows that total cost T_C of producing the given quantity of good X, viz. TC (Q_X) is equal to the sum of expenses incurred on labour (L.P_L) and capital (K.P_K).