Producing any good or service requires a number of different resources, and all of these need to be paid for.
Costs of production include all of the costs which are incurred by the producer such as wages, raw materials, rent, electricity, machinery and so on.
The cost of producing a good or service has a direct relationship with the incentive a firm has to produce (supply). If the cost increases, it is likely that the firm will supply less. Alternatively they could pass on the increased cost to consumers as a higher price but this is likely to then lead to a reduction in quantity demanded.
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Key terms:
Total cost – the total of all of the costs incurred by a firm in the production of a good or service
Fixed cost – costs which do not change with the level of output (e.g. rent)
Variable cost – costs which do change with the level of output (e.g. raw materials)
Average cost – the cost of producing one unit of output