Chapter 7: Problem 9

What are explicit and implicit costs?

Short Answer

Expert verified

Explicit costs are direct, out-of-pocket expenses incurred in the production of goods or services, such as wages, rent, and utilities. Implicit costs, also known as opportunity costs, are the indirect costs of using resources in production, which could have been utilized elsewhere, such as a business owner's time or the foregone income from using funds to start a business. Explicit costs are easier to identify and quantify, while implicit costs can be more difficult to measure. Both are taken into account when calculating the total cost of production or overall profitability.

Step by step solution

1. Definition of Explicit Costs

Explicit costs are the direct, out-of-pocket expenses incurred by a company or an individual in the production of goods or services. These costs represent actual cash outflows and are easily identified and quantified.

2. Examples of Explicit Costs

Common examples of explicit costs include: a. Wages paid to employees b. Rent for office or production space c. Raw materials and inventory d. Utilities such as electricity and water e. Taxes and insurance premium

3. Definition of Implicit Costs

Implicit costs, also known as opportunity costs, are the indirect costs of using resources in the production of goods or services. Implicit costs do not involve a direct cash outflow, but instead represent the value of the resources used in the production process which could have been utilized elsewhere. These costs are often more difficult to identify and quantify.

4. Examples of Implicit Costs

Some examples of implicit costs include: a. The value of a business owner's time invested in the company instead of working elsewhere. b. The foregone income from an individual's savings account when using the funds to start a business. c. The opportunity cost of using a company-owned building for production activities rather than leasing it out to another business. d. The wear and tear on machinery over time, reducing its resale value.

5. Comparing Explicit Costs and Implicit Costs

To summarize the comparison between explicit costs and implicit costs: - Explicit costs represent the actual cash outflows for the production of goods or services, while implicit costs represent the value of resources used that could have been utilized elsewhere. - Explicit costs are easier to identify and quantify, whereas implicit costs can be more difficult to measure. - Both explicit and implicit costs are taken into account when calculating the total cost of production or the overall profitability of a business.