6 1 Explicit and Implicit Costs, and Accounting and Economic Profit UH Microeconomics 2019

Economists include both implicit costs and the regular costs of doing business when calculating total economic profit. In other words, economic profit is the revenue a company generates minus the cost of doing business and any opportunity costs. Whether you realize it or not, you deal with both implicit cost and explicit cost while doing business. Implicit and explicit costs help you determine accounting profit and economic profit, opportunity cost, and more. Economists use both explicit and implicit costs in their analysis of profits. In this section, you’ll learn more about these types of costs.

  1. Depreciation is the decline in the value of any capital due to its constant usage.
  2. Examples of explicit costs include wages, lease payments, utilities, raw materials, and other direct costs.
  3. Economic profit is total revenue minus total cost, including both explicit and implicit costs.
  4. In contrast, implicit costs are not clearly defined, identified, or reported as expenses.
  5. But these calculations consider only the explicit costs.

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. They provide the business with their skill in lieu of a salary, which becomes an implicit cost. When a company hires a new employee, there are implicit costs to train that employee. If a manager allocates eight hours of an existing employee’s day to teach this new team member, the implicit costs would be the existing employee’s hourly wage, multiplied by eight.

Implicit cost allows us to make informed decisions by identifying opportunity cost. Individuals and firms can make better decisions in which not only explicit costs are considered but also implicit costs are included for all the available options. By considering explicit costs along with implicit costs, a comprehensive calculation of economic profit is made. This helps in evaluating different options when making decisions about resource allocation. However, these calculations consider only the explicit costs. To open her own practice, Eryn would have to quit her current job, where she is earning an annual salary of $125,000.

How to calculate the Explicit Cost?

Explicit costs help business firms in making pricing decisions for their products and budget for their operations. Setting the right price and making use of budgets is important for improving business performance. Let’s understand the concepts of accounting profit and economic profit with the help of calculation examples. Explicit costs are the actual expenses that are incurred when producing certain goods or services. Explicit costs are recorded in the books of accounts and are mentioned in financial records like the income statement and balance sheet.

What is a Cost?

We will learn in this chapter that short run costs are different from long run costs. Profit calculations are critical for any business in assessing its financial performance. The explicit costs are used to calculate accounting profits which give a good indication of the financial performance of a business.

What Is an Implicit Cost?

As a result, implicit costs may be more difficult to quantify than other types of costs. Implicit costs are technically not incurred and cannot be measured accurately for accounting purposes. There are no cash exchanges in the realization of implicit costs. But they are an important consideration because they help managers make effective decisions for the company. An implicit cost is any cost that has already occurred but not necessarily shown or reported as a separate expense.

Another 35% of workers in the U.S. economy are at firms with fewer than 100 workers. These small-scale businesses include everything from dentists and lawyers to businesses that mow lawns or clean houses. Examples of implicit costs include the loss of interest income on funds and the depreciation of machinery for a capital project. They may also be intangible costs that are not easily accounted for, including when an owner allocates time toward the maintenance of a company, rather than using those hours elsewhere. In most cases, implicit costs are not recorded for accounting purposes.

This helps the business firms in improving efficiency in resource allocation. Explicit Cost refers to the one paid to the factors outside the firm. Conversely, Implicit Cost are the one that arise from using the asset rather than renting it out. There are a number of differences between explicit cost and implicit cost, which has been explained in the article presented below, have a look.

Calculating explicit costs is simple as long as you know your business expenses. To calculate explicit costs, add up all of your business expenses on the general ledger. This could include things like insurance, rent, equipment, supplies, and the cost of goods sold, among other things. Your explicit and implicit costs total explicit costs add up to $25,000 for the period. You can plug this amount into other formulas, like the accounting or economic profit formulas, to find out financial information for your business. To calculate explicit costs, add together your business expenses on the general ledger.

Definition of Explicit Cost

Implicit costs are not clearly defined and don’t get reported as expenses. When a company allocates its resources, it forgoes the ability to earn money off the use of those resources elsewhere. Going to university entails an implicit cost in the form of money that could have been earned during that time. This helps the business to keep the accurate record of all the expenses incurred and hence provide financial accountability. Implicit cost is the opportunity cost of making a decision, and it is considered an expense in economics. Accounting profit and economic profit are the two main types of profit.

These costs represent a loss of potential income, but not of profits. Implicit costs are a type of opportunity cost, which is the benefit that a company misses out on by choosing one option or alternative versus another. The implicit cost could be the amount of money a company misses out on for choosing to use its internal resources versus getting paid for allowing a third party to use those resources.


These costs are not recorded or mentioned in the financial records of the business, like the income statement and balance sheet. However, these costs suggest the best alternatives that are neglected during decision-making. Let’s suppose that you have decided to start own business (own firm) instead of doing a job. In this situation, the job salary may be considered an implicit cost that you could have earned if you decided to do the job instead of starting your business. Maybe Eryn values her leisure time, and starting her own firm would require her to put in more hours than at the corporate firm.

Implicit cost is an opportunity cost that arises from the allocation of resources for a specific purpose and cannot be easily assigned a monetary value. Let’s look at both explicit and implicit costs in more depth. These expenses are a big contrast to explicit costs, the other broad categorization of business expenses. Explicit costs represent any costs involved in the payment of cash or another tangible resource by a company. Rent, salary, and other operating expenses are considered explicit costs.

While calculating true economic profit, we use economic cost in which opportunity cost or implicit cost is also included. This helps the businesses in evaluating the true value of alternative uses of resources and hence, better decisions can be made. Implicit costs refer to the opportunity costs of using the resources and are considered important while making economic decisions.

When combined together, explicit and implicit costs make up what is known to be the total economic cost. 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. To open his own practice, Fred would have to quit his current job, where he is earning an annual salary of \(\$125,000\). With implicit costs, you do not track them like business expenses in your books.

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