Reading: Explicit and Implicit Costs Microeconomics

Accounting costs are generally easy for business owners to identify, track, and record. You can use explicit costs to calculate your company’s profit and see where you need to make changes when it comes to expenses. Accounting profit is the money left over in a business after deducting explicit costs from total revenue. Explicit costs involve tangible assets and monetary transactions and result in real business opportunities. Explicit costs are easy to identify, record, and audit because of their paper trail. Expenses relating to advertising, supplies, utilities, inventory, and purchased equipment are examples of explicit costs.

Difference between Optimism and Pessimism

Implicit costs also include the depreciation of goods, materials, and equipment that are necessary for a company to operate. Depreciation is the decline in the value of any capital due to its constant usage. Implicit costs imply expenses where payments are not made out to any individual or firm. While accounting profit considers only explicit costs, economic profit considers both explicit and explicit and implicit costs implicit costs.

Let’s understand the concepts of accounting profit and economic profit with the help of calculation examples. The following table summarises the main points of difference between accounting profit and economic profit. Implicit Cost, also known as the economic cost, is the cost which the company had foregone while employing the alternative course of action. It is the value of sacrifice made by the entity at the time of exercising some other action. The cost occurs when an asset is used as a factor of production by the entity instead of renting it out. Another example of an implicit cost involves small business owners who may decide to pass on taking a salary in the early stages of operations to reduce costs and increase revenue.

Profit

By keeping the record of the explicit costs, businesses can control costs. Explicit Costs are the costs which involve an immediate outlay of cash from the business. The cost is incurred when any production process is going on, or activity is conducted in the normal course of business.

What are explicit costs?

These considerations help patients and healthcare providers make informed decisions that optimize health outcomes while managing costs effectively. In addition, you estimate that your annual implicit costs are $30,000 because this is the additional income you could have earned had you not attended college. Your total annual cost of attending college is now $55,000 ($25,000 plus $30,000). Therefore, your total cost of attending four years of college equals 4 times $55,000, or $220,000. If your additional lifetime earnings from having a four-year degree is more than $220,000, then, from a financial point of view, it would be worth it to attend college, and vice versa. Rent, salary, and other operating expenses are considered explicit costs.

• The cost is a charge for the use of factors of production like land, labour, capital and so on.
• Total cost is what the firm pays for producing and selling its products.
• Explicit costs are specific costs of a business that are normal in the course of operations and are directly linked to a firm’s profitability.
• This means when a company allocates its resources, it always forgoes the ability to earn money off the use of the resources elsewhere, so there’s no exchange of cash.
• This helps in evaluating different options when making decisions about resource allocation.
• In other words, these are the costs that are not directly linked to an expenditure.
• Explicit costs are easy to identify, record, and audit because of their paper trail.

What Are Examples of Explicit Costs?

These small-scale businesses include everything from dentists and lawyers to businesses that mow lawns or clean houses. Whilst explicit costs have a specific value, implicit costs are not always so clear cut. For example, spending 5 hours playing video games means those 5 hours cannot be used for studying. The implicit cost is the hours that could have been used for studying instead.

• This is because the cost of choosing option A has an explicit cost as well as an implicit cost of what could have been achieved otherwise.
• Second of all, there are implicit costs, which is a factor in calculating the firm’s economic profit.
• With implicit costs, you do not track them like business expenses in your books.
• They represent the opportunity cost of using resources that the firm already owns.
• For example, working in the business while not earning a formal salary, or using the ground floor of a home as a retail store are both implicit costs.
• The following table summarises the main points of difference between implicit cost and explicit cost.

Decision-making

The former is an out of pocket cost, while the latter is an opportunity cost. Subtracting the explicit costs from the revenue gives you the accounting profit. Explicit costs are the culmination of all direct and indirect expenses recorded in a company’s ledger.

The value by which is not necessary monetarily quantifiable, but is still considered as a cost. Explicit expenses are evaluated as the total business-related expense incurred—reflected in a company’s cash outflow. Also, it is the aggregate of money expended on equipment, raw material, rent, salary, wages, administrative costs, sales expenses, insurance premiums, and advertisements. For computing accounting costs, only explicit expenses are considered, as they are mentioned in the general ledger of a company. Accounting costs are calculated to compute a company’s accounting profit. For example, when a company buys an advertisement space in a newspaper, it pays the newspaper agency in cash.