Cost

Updated Dec 31, 2022

Definition of Cost

Cost is defined as the amount of money or resources that must be expended in order to produce or acquire something. That means it includes both the direct and indirect expenses associated with a product or service. Direct costs are those that are directly related to the production of a product or service, such as raw materials, labor, and overhead. Indirect costs are those that are not directly related to the production, such as marketing, research and development, and administrative costs.

Example

To illustrate this, let’s look at an imaginary company called ABC Inc. ABC Inc. produces and sells widgets. For the sake of this example, we’ll assume that, to produce a single widget, ABC Inc. needs to purchase raw materials for USD 10.00, hire a worker for USD 20.00, and pay USD 5.00 for overhead costs. Therefore, the direct costs for producing one widget add up to USD 35.00.

In addition to that, ABC Inc. also needs to spend money on marketing, research and development, and administrative costs. Let’s assume these costs add up to USD 15.00 per widget. As a result, the total cost for producing one widget is USD 50.00 (i.e., 35 + 15).

Why Cost Matters

Cost is an essential concept for understanding the economics of any business. Businesses need to understand their costs in order to make informed decisions. For example, if a business knows its costs, it can determine the price it needs to charge to make a profit. Similarly, it can also use cost information to decide which products or services to produce and which ones to discontinue. In other words, if a business doesn’t fully understand its costs it is at risk of losing money and going out of business. In addition to that, on a macro level, cost information can also be used to compare the efficiency of different production methods or companies.