Implicit Cost
March 31, 2009
Overview
Implicit cost, according to economists, happens when an individual foregoes an alternative action, without making the actual payment. It is basically a cost represented by a lost chance, say in the use of a company’s resources, more often excluding cash. The costs are intangible as they are hardly accounted for.
For instance, one may decide to go to the movies instead of work and earn extra cash. The individual will incur explicit costs by buying say a soda and the movie’s ticket. The implicit costs in this case will be what he would have earned, if he had foregone the movie and work. Another illustration is a business owner who exerts so much pressure in the maintenance of the company, instead of working on expanding the actual business.
Implicit costs and economic profits
Implicit costs, according to microeconomics, are a component of an economic profit. The total revenues, less implicit and explicit costs equal economic profit. Note that accounting profit is as a result of total revenues less explicit costs, but because economic profit encompasses opportunity costs, it will either be equal or less than accounting profit. Explicit costs, added to implicit costs equals total costs. Note that implicit cost is a component of the total cost and not equal to it.
For instance, from a company or firm’s point of view, an implicit cost is an opportunity cost of using its own resources. The implicit cost therefore is the amount of revenue which its own resources could generate in their best alternative use. The best alternative use characteristically signifies the opportunity cost. This is why, unlike an explicit cost which is not part of an economic cost, an implicit cost measures the revenue that can be generated, less the potential gain.
When calculating or measuring an implicit cost, in this case the opportunity cost, one looks at the best possible, but forgone opportunity or decision to create extra revenue. For instance, factory A has a total number of 30 employees and produces bicycles annually, which create total revenue of say $30,000. The same factory could have the same number of employees produce textiles, which could create total revenue of $70,000.
Still on point, factory A could still use the same workforce and materials to produce plastic toys, which could create total revenue of $20,000. Therefore, the total implicit costs of factory A will be equal to $40,000. Because the best alternative option of the factory would have produced $70,000, therefore less the $30,000 it generates.
Note that when calculating implicit costs, one ignores the less profitable options available, such as the option of factory A to produce toys, which would generate $10,000 lower than its normal revenue.
Is Investment an implicit Cost?
According to the definition of implicit cost which means a cost standing in for a lost opportunity by using company’s resources, excluding money, investment as an implicit cost is still debatable among pundits in the economic world. But rationally, according to opportunity cost, investments can be an example of implicit costs. This is because it is a firm or company investing its own money in something that could have been invested in something else. In other words, it is an opportunity cost incurred by a firm using their own money.
Conclusion
When compared to explicit costs, an implicit cost cannot be counted in terms of money but an explicit cost can because it is a direct concrete cost. In simple terms, an implicit cost is as a result of a firm or individual, foregoing a satisfaction in search of an activity that will not reward them by any form of payment of by any money. The cost starts and ends with sacrificing both the benefits and satisfaction.
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