The economic rule of costs
Consumers would like to have more economic goods, but resources to produce them are scarce. How much of each desired good should be produced? Every economic system must balance consumers’ competing desires. When decisions are made in the political arena, the budget process performs this balancing function. Legislators, a central planning committee, or a monarch decide which goods will be produced and which will be forgone. Taxes and budgets are set accordingly.
In a market economy, though, consumer demand and production costs are central to performing this balancing function. The demand f o r a product represents the voice of consumers instructing firms to produce the good. On the other hand, a firm’s costs represent the desire of consumers not to sacrifice goods that could be produced if the same resources were employed elsewhere. A profit-seeking firm will try to produce only those units of output buyers are willing to pay full cost for. Proper measurement and interpretation of costs by the firm are critical to both the firm’s profitability and the efficient use of resources.