The Concept of Cost

Cost may be one of the most confusing yet one of the most important concepts in intermediate economics. It is a key element of decision making, so it is worthwhile to clarify this concept.

There are several important types of cost to understand and be able to distinguish:

a. Opportunity cost
Opportunity cost includes all costs associated with an alternative, whether the costs are explicit or implicit (such as foregone opportunities). Opportunity cost depends on the decision being made and the time (and corresponding circumstances) at which that decision is being made.

b. Economic versus accounting costs
When making economic decisions, we must be sure to consider all relevant explicit and implicit costs.

c. Sunk versus nonsunk costs
Sunk costs are those that are unavoidable for the purposes of the decision under consideration. They should be ignored when making the decision. Nonsunk costs are avoidable for the purposes of the decision under consideration. They should be taken into consideration when making the decision.

d. Fixed versus sunk costs
Some costs may not vary with changes in (positive) output level, but still be avoidable by producing zero output. These costs may be referred to as avoidable fixed costs. They are not sunk.