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December 16, 2019 

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LAW OF DIMINISHING MARGINAL RETURNS: A principle stating that as more and more of a variable input is combined with a fixed input in short-run production, the marginal product of the variable input eventually declines. This is THE economic principle underlying the analysis of short-run production for a firm. Among a host of other things, it offers an explanation for the upward-sloping market supply curve. How does the law of diminishing marginal returns help us understand supply? The law of supply and the upward-sloping supply curve indicate that a firm needs to receive higher prices to produce and sell larger quantities. Why do they need higher prices?

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ACCOUNTING COST:

An actual outlay or expenses incurred in the production of a good that shows up in a firm's accounting statements and records. Accounting cost is an explicit payment (that is, money changing hands) incurred by a firm. Accounting cost, while very important to accountants, company CEOs, shareholders, and the Internal Revenue Service, is only minimally important to economists. The reason is that economists are more interested in economic cost (also called opportunity cost), which is the value of foregone production.
Accounting cost is essentially an out-of-pocket, explicit payment that generally compensates the resources used by a firm for the opportunity cost incurred in production. A worker like Phoebe Pankovic, for example, might be paid $10 an hour to produce Wacky Willy Stuffed Amigos (those cute and cuddly armadillos and tarantulas) to compensate for the $10 worth of other goods she is NOT producing at another job. That is, Phoebe could be producing $10 worth of Hot Momma Fudge Bananarama Ice Cream Sundaes rather than Wacky Willy Stuffed Amigos. This $10 hourly expense is an accounting cost of the firm that is also compensation for the economic cost of the worker.

However, an economic cost need not be an accounting cost and vice versa.

  • Economic Cost, No Accounting Cost: In some cases, the resources used by a firm for production incur an economic cost without an explicit payment showing up on the official accounting records. One of the more important examples, especially when the topic turns to the analysis of short-run production, is normal profit. The entrepreneurs of a firm incur the opportunity cost of foregone profit from another business activity, but this is never considered an accounting cost.

  • Accounting Cost, No Economic Cost: Alternatively, an accounting cost incurred by a firm might not be paid as compensation for an economic cost. Suppose for example, that Phoebe Pankovic receives an hourly wage of $10 to produce Wacky Willy Stuffed Amigos. However, her opportunity cost, the value of Hot Momma Fudge Bananarama Ice Cream Sundaes production foregone is only $7. In this case only $7 of the accounting cost corresponds to an economic cost. The remaining $3 is an accounting cost that is not compensation for any economic cost. In effect, this extra $3 is actually part of the economic profit of the firm that is received by the worker rather than the entrepreneurs.

<= ABSTRACTIONACCOUNTING PROFIT =>


Recommended Citation:

ACCOUNTING COST, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2019. [Accessed: December 16, 2019].


Check Out These Related Terms...

     | accounting profit | normal profit | economic profit | profit |


Or For A Little Background...

     | opportunity cost | explicit cost | economic cost | cost | production | production cost | business | factors of production | microeconomics | short-run production analysis |


And For Further Study...

     | total cost | variable cost | fixed cost | average cost | marginal cost | legal business organizations | firm objectives | opportunity cost, production possibilities | profit maximization |


Related Websites (Will Open in New Window)...

     | American Accounting Association | Internal Revenue Service |


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