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Definition of Implicit Cost:
An implicit cost
is the value of benefits given up that do not require an outlay of money. For example, if a business uses a resource to produce a product it forgoes the opportunity to use the resource elsewhere. The implicit cost is the income it sacrifices by using it in the product rather than selling the resource in the market.
A company’s costs can be separated into two components – explicit costs, which require cash expenditures, and implicit costs, which do not require cash expenditures. Implicit costs measure the value sacrificed by choosing to use a company's scarce resource in a particular way. Once used, the opportunity to earn money by using it again is lost.
Accounting profits include only explicit costs, which are easily identified business expenses requiring money to be spent. Examples of explicit costs include, but are not limited to, rent, plant and equipment, wages, raw materials, utilities, and insurance. In general, the difference between total revenues (sales) and total explicit costs equals the accounting profit.
Economists are more interested in economic profit because it includes implicit costs. Economists measure economic profit as revenues less the sum of explicit and implicit costs. Economists believe businesses and individuals need to include both the explicit and implicit costs to reach the optimal decision because some value needs to be placed on the benefits given up. The use of a resource prevents a business from using the resource in another venture, so there is a lost opportunity, which is a cost. Unlike explicit costs, implicit costs can be very hard to measure. It is common for small business owners “to do it all” rather than hiring an employee or a subcontractor. This takes time away from spending time on more productive tasks, such as marketing. The lost business is a cost that is very difficult to measure. The savings from the small business owner doing all the work may be less than the lost revenue resulting from spending less time selling. Other costs are easy to measure. For example, assume Bill owns an office and starts a new business. Instead of renting his office in the open market for $20,000 a year, he chooses to let his company use the space. There is an implicit cost of $20,000 that would not be included in the accounting profit.
Many confuse opportunity cost and implicit cost. The subtle difference is an opportunity cost includes the explicit and implicit costs of the best-foregone decision. For example assume that today George’s two best choices are: take today off to play golf or go to work. The opportunity cost is the sum of the explicit cost to play a round of golf, plus the implicit cost of the lost income from taking the time off work.
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