By cost principle, Nye can determine the profitability of production, whether the production is profitable or not and whether we should continue the production or not. There are two categories of cost in farming.
i) Fixed cost
ii) Variable cost
i) Fixed cost:Fixed cost refers to the farming expenses, which do not change with output, e.g. taxes, hank interest, buildings, machineries, insurance etc. These are the expenses which must be paid even though nothing is produced.
ii) Variable cost:Variable cost refers to farming expenses, which do change with output.- They are incurred only when the ram is operated. Fertilizer, seed, labour, irrigation etc.
The cost principle follows the two rules.
1. If the returns are greater than the total cost (PC + VC), more resources can be used if more capital is available.
2. If the returns are less than the total cost, but still greater than the variable cost, the production should be continued.
Analysis of the first rule is that the farm operator will have the greatest profit and in case of second rule, the farm operator will have the smallest loss by continuing the farm operation.
For example: Variable cost (VC) = 7
Fixed cost (FC) = 3
Total cost = Tk 10
Suppose, production value is Tk.9 or Tk.13 When the production value is Tk.13, which is greater than the total cost that is _profit concern. So, we should apply more variable cost to achieve the greatest profit. When the production value is Tk.9, it is loss concerned but since the fixed cost must be paid, if we do not continue production the loss is ‘11.3 and if we continue production, the loss is (Tk.10 = Th.1 only. That is why; the farm operator will continue the production to aim at the smallest loss.
Application: By the help of cost principle, we can determine whether a production is profitable or not. Truly speaking, all farms and industries of the country are established depending on cost principle.