February 17, 2019 

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ACTION LAG: In the context of economic policies, a part of the implementation lag involving the time it takes for appropriate policies to be launched once they have been agreed to by policy makers. Another part of the implementation lag is the decision lag. For fiscal policy, this involves appropriating funds to government agencies (for government spending) or changing the tax code (for taxes) For monetary policy, this involves the buying and selling government securities in the open market. The action lag is usually shorter for monetary policy than fiscal policy.

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The opportunity cost of using labor, capital, land, and entrepreneurship in the production of goods and services. The price received by a seller must be high enough to cover production cost. The law of supply is based on the proposition that production cost increases with an increase in the quantity produced and supplied.
Production cost is important to the supply side of the market. Sellers base supply decisions on the cost of production. In that production cost generally increases as more of a good is production, the supply price also tends to rise with the quantity supplied.

All Sorts of Expenses

Production cost includes the opportunity cost of using the four factors of production (labor, capital, land, and entrepreneurship). It includes those expense items that are traditionally considered as the "cost of doing business." However, it also includes other less obvious costs.

To run through the assortment of costs, consider the production of Wacky Willy Stuffed Amigos, a cute and cuddly line of collectible stuffed creatures.

  • Labor: At the top of almost any list of business expenses are the wages paid to labor. This includes hourly wages, monthly salaries, and fringe benefits. It includes anything and everything that compensates workers for the opportunity cost of foregone production. The Wacky Willy Company incurs the cost of employing thousands of workers, including those doing the actual production as well as assorted executives, accountants, and other administrators.

  • Materials: Another noted expense for production operations like Wacky Willy Stuffed Amigos is for the materials that make up the product. This includes fabric, stuffing, thread, and cute little buttons for the eyes. The payments for these materials are typically used by another firm to pay its production cost.

  • Capital: The opportunity cost of using capital goods--buildings, machinery, tools, vehicles, and assorted equipment--is also important, but not always evident. The Wacky Willy Company, for example, borrowed money to purchase sewing machines. The interest expense on the loan is a key part of the cost of the capital. Other producers might incur a production cost for renting factory space, office space, or vehicles from another company.

  • Entrepreneurs: The organizing risk takers also incur an opportunity cost in the production of a good. The entrepreneur responsible for Wacky Willy Stuffed Amigos is William J. Wackowski. He undertook the risk of launching The Wacky Willy Company and producing the adorable stuffed creatures. The opportunity cost of his entrepreneurial effort is profit--specifically a normal profit. A normal profit is the profit that could be earned in the next best alternative production operation.

More Than Transformation

The production cost incurred in the physical transformation of materials into a finished product tends to be extremely important for most suppliers. However, the act of production includes more than transformation. It also includes transportation, moving things around. As such, production cost also includes the cost of transporting inputs and outputs, getting the materials to the factory and getting the finished product to the buyers.

Production cost also includes administrative cost, marketing cost, and any other expense needed to supply a good, to offer it for sale to buyers.

Explicit and Implicit

Most production cost for most firms involves out-of-pocket payments to resource owners, what is technically termed explicit cost. However, some opportunity cost of production is implicit cost, which does not involve an out-of-pocket payment. Implicit cost can be either internal or external.
  • Internal: The most important internal implicit cost is a normal profit to compensate entrepreneurship for the opportunity cost of foregone production. However, labor, capital, and land resources also can incur implicit opportunity cost. For example, William J. Wackowski was not explicitly paid for his labor and sewing machine, when he produced the first Wacky Willy Stuffed Amigos in his garage.

  • External: External implicit cost is that incurred beyond the confines of the production process and the producer. This often involves a bi-product or waste material discharged into the environment that imposes an opportunity cost on others. For example, The Wacky Willy Company blows excess, unneeded stuffing fibers out through an exhaust pipe. Unfortunately this waste fiber creates breathing problems and medical expenses for people living around the factory. They incur the cost. The Wacky Willy Company does not.

The Law of Supply

Production cost forms the foundation of supply and the law of supply. Sellers must receive a price high enough to cover production cost if they are to supply a good. Two notions are particularly important in this regard.
  • Only Internal Cost: First, the supply decision relies only on internal cost, both explicit and implicit. A seller is willing and able to offer a good for sale if the price is sufficient to cover all internal cost. This includes both explicit and implicit cost as long as they are incurred by the firm. The supply price is, in effect, the minimum price needed by a seller to cover all internal cost. Most important is the internal implicit cost of a normal profit. Supply price also includes a normal profit.

  • Increasing Cost: Second, production cost generally increases with the production of a good. This is often explained through the law of increasing opportunity cost associated with the production possibilities curve or the law of diminishing marginal returns underlying the analysis of short-run production. If production cost increases with the quantity produced and supplied, then so too does the supply price, which results in the law of supply.


Recommended Citation:

PRODUCTION COST, AmosWEB Encyclonomic WEB*pedia,, AmosWEB LLC, 2000-2019. [Accessed: February 17, 2019].

Check Out These Related Terms...

     | supply | market supply | supply price | quantity supplied | law of supply | supply schedule | supply curve | supply space | supply determinants | change in supply | change in quantity supplied | producer surplus |

Or For A Little Background...

     | production | opportunity cost | factors of production | explicit cost | implicit cost | scarcity | limited resources | good | service | labor | capital | land | entrepreneurship |

And For Further Study...

     | competition | production possibilities | law of increasing opportunity cost | competitive market | market | Marshallian cross | opportunity cost, production possibilities | law of diminishing marginal returns | short-run production analysis | total cost | marginal cost |

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