What is the Theory of Costs ? In practical economics ,the theory of cost implies the determined value/price of all inputs of production . These includes Land ,labor capital [basic factors] taxes , fixed and variable assets .Based on these inclusion ,this company now decides on the final consumer price which of course should not be too high or low when compared with existing similar products of their contemporaries .
This is to ensure profitability in a competitive market so that the very purpose of investment is not defeated. In order to maximize profit ,some companies go into raw materials production which may be long or short term investment so that overall turnover will surpass that of their contemporaries in the competitive market .
In the Cost Theory, there are two types of costs associated with production – Fixed Costs and Variable Costs.
A. Fixed Cost
Fixed costs are costs that do not vary with different levels of production and fixed costs exists even if output is zero. Example: rent or salaries.
B. Variable Costs
Variable Costs are costs that vary with the level of output. Ex: electricityCost. functions are derived functions. They are derived from the production function, which describes the available efficient methods of production at any one time.
Economic theory distinguishes between short-run costs and long-run costs. Short-run costs are the costs over a period during which some factors of production (usually capital equipment and management) are fixed.
the cost-of-production theory of value is the theory that the price of an object or condition is determined by the sum of the cost of the resources that went into making it. The cost can comprise any of the factors of production (including labor, capital, or land) and taxation.
The theory makes the most sense under assumptions of constant returns to scale and the existence of just one non-produced factor of production. These are the assumptions of the so-called non-substitution theorem[clarification needed]. Under these assumptions, the long-run price of a commodity is equal to the sum of the cost of the inputs into that commodity, including interest charges.
Historical development of theory
Historically, the best-known proponent of such theories is probably Adam Smith. Piero Sraffa, in his introduction to the first volume of the "Collected Works of David Ricardo", referred to Smith's "adding-up" theory. Smith contrasted natural prices with market price. Smith theorized that market prices would tend toward natural prices, where outputs would stand at what he characterized as the "level of effectual demand". At this level, Smith's natural prices of commodities are the sum of the natural rates of wages, profits, and rent that must be paid for inputs into production. (Smith is ambiguous about whether rent is price determining or price determined. The latter view is the consensus of later classical economists, with the Ricardo-Malthus-West theory of rent.)
David Ricardo mixed this cost-of-production theory of prices with the labor theory of value, as that latter theory was understood by Eugen von Böhm-Bawerk and others. This is the theory that prices tend toward proportionality to the socially necessary labor embodied in a commodity. Ricardo sets this theory at the start of the first chapter of his Principles of Political Economy and Taxation. He also refutes the labor theory of value in later sections of that chapter. Taknaga advances a new interpretation that Ricardo had cost-of-production theory of value from the start and presents a more coherent interpretation based on texts of Principles of Political Economy and Taxation. This alleged refutation leads to what later became known as the transformation problem. Karl Marx later takes up that theory in the first volume of Capital, while indicating that he is quite aware that the theory is untrue at lower levels of abstraction. This has led to all sorts of arguments over what both David Ricardo and Karl Marx "really meant". Nevertheless, it seems undeniable that all the major classical economics and Marx explicitly rejected the labor theory of price().
A somewhat different theory of cost-determined prices is provided by the "neo-Ricardian School"  of Piero Sraffa and his followers. Shiozawa presented a modern interpretation of Ricardo's cost-of-production theory of value.
The Polish economist Michał Kalecki  distinguished between sectors with "cost-determined prices" (such as manufacturing and services) and those with "demand-determined prices" (such as agriculture and raw material extraction).
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Theory of costs :
is a theory used to understanding the costs of production that allow firms to define the level of output that can generates the greatest level of revenue at the lowest cost and there are about three ways used based on theory of costs to helps in determining that level of output and these three ways are :
- Fixed Costs : are fixed costs which are paid monthly or regularly such as rents, utility bills, .. etc and these costs don't don't change with the change in quantity of goods produced .
- Variable Costs : are costs which are not fixed but these costs typically change with the quantity produced such as wages, where producing more goods need to more workers and this will increase the cost of wages and vice versa .
- Marginal Costs : are the increase in total cost that results from increasing production by one unit of output such as getting bulk purchases deals from suppliers, finding the best machinery production rates and these costs .
Full Costing Theory: This theory embodies one of the first theories in the science of price accounting. On the units sold, this method is one of the lowest methods in terms of gross profit as it is the method and how accepted from the point of processing external reports and this theory is based on the principles, including: Productive job, marketing profession or administrative and finance job. 2 - Complete the estimate of the inventory of goods from full production or under operation, either at the beginning or the last with respect to the total price. 3. Sorting the enforcement vehicles so as to separate the elements of direct prices and elements of indirect commissioning. 4 - Installing price vehicles in four groups so that the price can be measured in conformity with the functional activities performed by the industrial unit in the following order: Direct value = the price of direct raw materials + direct wages + other direct industrial expenses. Issue price = direct price + indirect industrial expenses. Sale value = cost of production + selling and distribution expenses. Total Value = Selling Price + Administrative Expenses. 5. Preferring direct price elements and allocating them directly to the final products, while impatient with their share of the components of the indirect value using actual or estimated loading amounts. 6 - The total price in the presence of normal operating conditions must be the minimum cost of sale. Characteristics of this theory: This theory is characterized by the following specifications: 1 - the cooperation of this utility theory to determine the result of the existing activity of winning or loss properly as a result of material input This benefit theory helps to define long-term price plans and strategies. 3. The price of the product should not be less than the total price. Critical views addressed to that theory: As taken on that theory as follows: 1 - fluctuation of unit costs produced and therefore according to the conversion of the amount of issue if the unit price decreases, and if it decreases, the price multiply, as a result of shipping indirect prices, including fixed costs. 2. The valuation of the commodity balance according to the value of production is the reason for transferring part of the fixed prices that fall within the indirect industrial expenditures to the coming periods and therefore it is incompatible with the principle of independence of financial periods. Total available capacity and costs corresponding to the utilized and unused part. It is assumed that it carries the actual activity with its share of prices only and not complete according to that theory