Cost of any product can be defined as the expenditure that is needed in order to produce that product or make it usable for consumption purpose. Now, Cost Structure of a firm can be broadly categorized into two segments – Implicit costs and Explicit Costs.
What is Explicit Cost ?
Explicit costs are cash payments which a firm makes to other factor owners for purchasing or hiring various factors of production. For example, salary payment to the factory workers, rental payment for land etc. are part of explicit costs.
What is Implicit Cost ?
The implicit costs incurred in producing a specific commodity does not actually exist in the account books as it does not involve any monetary exchange as an explicit cost would have. Suppose when a firm allocates its resources to perform various jobs it forgoes an amount which it could have earned while putting the resources to some other job.
Now you may come across two other terminologies with regard to cost – Accounting cost and Economic cost.
What is the difference between Accounting Cost and Economic Cost?
Accounting cost includes the expenses on acquiring factors of production along with depreciation cost for capital equipment. On the other hand, Economic cost takes into account in addition to accounting cost, the amount of money the entrepreneur could have earned if he had invested his money and sold his services to next best alternative use, which is the Implicit cost basically. So, Economic cost is the sum of Accounting cost and Implicit cost.
What is Economic Profit ?
An Economic profit is earned when total revenue earned from selling a product exceeds the sum of the entrepreneur’s or firm’s explicit and implicit costs. So, Economic profit is the difference between Economic cost and revenue earned. In the short run Implicit costs are a fixed amount that need to be added to the explicit costs to calculate Economic Profit.
Another very important and closely related concept is Opportunity Costs. It is probably one of the most popular concept in Economics.
What is Opportunity Cost?
The opportunity cost of producing one unit of commodity A is the amount of commodity B that must be forgone to use available resources for producing commodity A and not commodity B. For example, A farmer who is producing corn can also produce wheat with the land and labour hours. However, he chose to produce corn and hence, the opportunity cost of producing 1kg corn is the amount of wheat that he had to forgo to produce the corn.
Now, you may think Implicit costs and Opportunity costs are kind of similar. Well, this is a common thought. However, to clarify, Opportunity costs include both explicit and implicit costs. In other words, implicit costs are a type of opportunity cost. Suppose a person decided to drop out of college and joined a job. If he continued going to college his implicit cost would have been $50 k which he earned as a salary in the first year and opportunity cost will be $50 k plus the tuition fee of that year.
So, opportunity cost = what you sacrifice by not choosing the next best option.
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