Meaning and Definition
Cost of production refers to the total sum of money needed for the production of a particular quantity of output. As defined by Gulhrie and Wallace, “In Economics, cost of production features a special meaning. It is all about the payments or expenditures essential to get the factors of production of land, labor, capital and management needed to produce a commodity. It signifies the money costs which are to be incurred for acquisition of the factors of production.” In the words of Campbell, “Production Costs are the costs which should be essentially received by resource owners so as to presume that they will continue to supply them in a specific period of time.”
Elements of Production Cost
The key elements included in the production costs are as follows:
- Purchase of raw machinery
- Installation of plant and machinery
- Wages of labor
- Building rent
- Interest on capital
- Wear and tear of building and machinery
- Advertisement expenses
- Payment of taxes
- Insurance charges
- The imputed value of factor of production owned by the firm itself is also added in the production cost.
- The production cost also includes the normal profit of the entrepreneur.
Formula for computing Production Costs
The general formula used for computing production cost is:
Production cost per item = Fixed Cost (FC) + Variable cost (VC) / No. of units produced
Calculating production cost
The key steps involved in computation of production cost are:
- Determine the fixed cost. These are the costs which do not alter on the basis of the number of products produced. This includes the rent paid for building, salaries of the employees, and utility costs.
- Estimate the variable costs. These are the costs that change with a change in the quantity of production. For example, if you are making a cake, some of the variable costs would be flour, eggs, and sugar.
- Add the fixed costs to the variable costs and divide this number by the number of items produced thus reaching the production cost for one item.