Basic Cost Concepts
Cost is central to effective decision making in all organizations: public, private, and quasi-public (organizations that are neither fully public nor completely private). It is the cement that holds together the different elements of an organization into a viable operating structure. For government in particular, it has become the principal guiding force that underlies a majority of decisions it makes, especially those related to the provision of public goods and services. To put it simply, without some knowledge of costs it will be impossible for a government to know what kinds of goods and services it can provide, the level of their provisions, and the length of time for which they will be provided. Even for those goods and services that are considered meritorious, such as education and health care, cost remains the single-most overriding concern.
This chapter introduces several key concepts that are useful in a cost study, in particular how costs are defined, measured, analyzed, and evaluated. In presenting this introduction, the chapter identifies and distinguishes between different categories of costs; illustrates the contrast between cost, expense, and expenditure; explains the rationale for using different types of prices in government; discusses the relationship between cost and inflation; and suggests a number of cost principles.
The term cost ordinarily means the value of economic resources used in the production or delivery of a good or service. The use of the word value has a special meaning in cost calculation: it indicates the actual dollar amount spent on materials, labor, and other factors of production. Since a government does not produce goods for direct public consumption (with some exceptions, such as electricity, water, and a few others), the costs a government incurs in providing goods and services include the costs of acquisition, maintenance, and delivery.
Costs are generally expressed in cost units. A cost unit is a unit of a good or service in relation to which costs are ascertained. It is the basic unit of measurement used in all cost calculations. Examples of cost units in government will be kilowatt hours of