Brief History of Cost

Compared to value, cost has had a much quieter ideological history, at least on the surface.

Adam Smith defined it as the amount of money a capitalist must pay out to produce a commodity. Marx had very little to say on the subject, although his interpretation was similar to Smith's — cost is the capitalist's total outlay in production.1

However, a very different interpretation of cost was occasionally expressed by economic thinkers. Marx used the terms "real cost" and "social cost" when he discussed the pain, toil, disease, and pollution experienced by workers and society at large, although he did not formalize this notion. Alfred Marshall similarly referred to the pain or disutility of work as a cost.

The troublesome contradiction between these two interpretations of cost — the capitalist’s financial outlay and social pain — was resolved for standard thinkers with the concept of opportunity cost, which is usually defined as the value of the best forgone alternative action.

In the context of production, opportunity cost means the following: if a set of inputs is used to produce commodity A when it could have been used to produce best alternative commodity B, then the opportunity cost of producing A is the value of B.

In other words, opportunity cost measures the relative merits of allocating inputs to various production possibilities through the alternative benefits that are expected to result.

Opportunity cost avoids the outlay-pain confusion by dissociating cost from the production process and attaching it to alternative consumption benefits. In the words of Frank Knight, a pioneering standard economist:

If costs are stated in terms of alternative commodities and all reference either to 'sacrifice' or 'outlays' simply omitted, we retain the scientific content of cost of production theory while side-tracking the sources of a century and a half of controversy.2

The following is a classic contemporary statement on this topic:

If you purchase a house, you may not be able to afford to eat at expensive restaurants as often as in the past. If a firm decides to retool its factories, it may have to postpone plans for new executive offices. If a government expands its road networks, it may be forced to reduce its outlays on school buildings. Economists say that the true costs of such decisions are not the number of dollars spent on the house, the new equipment, or the roads, but rather the value of what must be given up in order to acquire the item—the restaurant meals, the new executive offices, or the new schools. These are all opportunity costs because they represent the opportunities the individual, firm, or government must forego to make the desired expenditure.3

In standard economics today, two concepts of cost are generally recognized.

The first is opportunity cost, which reigns supreme as a broad explanatory principle, especially in introductory economics classes.

The second is "accounting cost." This is the "outlay" idea noted above, and is normally used when the nitty-gritty of market behavior is discussed.

One standard economics text includes both terms in its glossary, but uses "cost" by itself to mean accounting cost. The definition it provides is, "Total payment made by a firm for the services of factors of production."4

It is worth nothing that, of the three cost concepts that have arisen in the history of standard thought, opportunity cost and outlay survive, but pain is gone. The disappearance of this intuitively obvious interpretation is of deep ideological significance, and is usually kept well hidden. The following statement may be the only one in the standard literature that reveals the true situation:

We caution that 'labor, toil, trouble, and pain' are not what is meant by costs. 'Bads' associated with an action are not its costs; they are part of the act.5

While the conservative authors of this text deserve credit for their candor, they neither reveal the history nor explain the logic behind their assertion.

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