Introduction to Costs
The term “theory” is a Greek derivative and means: “seen from above.” That is to say that a theory is an overall discussion of a subject, taken out of the concrete decisionmaking situations, while focusing on the general aspects, and not the specifics.
But in order to understand the general aspects, you have to understand the specifics, and the theory cannot be so general that it does not apply to the specific decisionmaking situation.
The defining of a cost theory, focusing on separating different decision-making occasions, and thereby allowing for the understanding and description of the differences these factors present in cost-theory, is a problem we hope to solve with this text.
For a given firm, pricing as well as production planning require thorough knowledge of the firm’s costs at different activity levels
For instance the owner of a pizzeria needs to know about costs incurred to the firm at different activity levels (number of pizzas produced) when pricing in connection with a brochure that is to be distributed door-to-door. Costs vary with activity level, as purchases of raw materials, hiring of employees, choice of oven, and maybe even size of the location depend on the chosen level of activity. Which costs vary with the activity level depend on the owner’s decision-making horizon, e.g. if there are big differences between planning the daily operations and strategic considerations regarding the pizzeria’s future.
With the purpose of assisting the decision maker (e.g. the owner of the pizzeria) cost functions expressing cost as a function of the activity level are devised. Depending on the functions of the decision-making situation, the following cost functions are applied…
Different Cost Types as a Function of Different Decision-Making Situations
In any given company there are a number of typical cost types which vary in tact with specific decisions: time horizon, product type, and production conditions, just to name a few.
- For a hotel, the cost calculation for a vacant room per night, depending on the decision-making occasion, could result in numbers as different as DKK 20 and 400.
- For an airline the calculation of costs per seat between Oslo and Copenhagen result in numbers as different as DKK 80 and 460.
- For Carlsberg the cost calculation of producing one premium pilsner result in numbers as different as DKK 0.80 and 2.20.
- For TDC the cost calculation for one minute of calling on the cellular net in numbers as different as DKK 0.15 and 0.65.
The decision-making occasion has to be specifically defined…