Explicit and Implicit Costs: Definition & Examples
What are Explicit and Implicit Costs?
An explicit cost is the clearly stated costs that a business incurs. For example, employee wages, inputs, utility bills, and rent, among others. These are the costs which are stated on the businesses balance sheet.
By contrast, implicit costs are those which occur, but are not seen. In other words, these are the costs that are not directly linked to an expenditure. For example, a factory may close down for the day in order for its machines to be serviced. The explicit cost to repair the machines is $10,000. However, the factory has lost a whole days output which has cost it $50,000 in lost production. This indirect cost is known as the implicit cost.
- An explicit cost is that which is clear and identifiable in monetary terms.
- An implicit cost is the cost of choosing one option over another.
- Accounting profit is revenue minus explicit costs, whilst economic profit is revenue minus explicit AND implicit costs.
Explicit costs are those which are clearly stated on the firm’s balance sheet, whilst implicit costs are not. Instead, it is the indirect cost of choosing a specific course. 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.
How to Calculate Implicit Cost
Implicit costs are costs that occur due to a specific path or option being chosen. It represents an opportunity cost when the firm uses resources for one use over another. The implicit cost is the cost of the action that is foregone. For example, a manager may need to train their staff, which requires 8 hours of their time. The implicit cost is the cost of their time which could have been employed doing their other daily tasks. In turn, this costs the firm however much output that manager would have created had they not needed to train the employees.
Another example of an implicit cost is that of going to college. The explicit cost may be $30,000 per year. However, there is also an implicit cost. A student going to college could be working instead. Even in a minimum wage job, that would be approximately $12,000 per year – which is the implicit cost. They could be earning $12,000 a year if they didn’t go to college. So the total economic cost is the explicit cost of tuition at $30,000 and the implicit cost of not working which is over $12,000 – meaning a total economic cost of $42,000.
Explicit Cost Examples
An explicit cost is one that is a clear and obvious monetary amount made by the firm. It has a clear monetary amount which can be seen in the firm’s financial balance sheet. Such examples include:
- Advertising and marketing costs.
- Employee wages, bonuses, commissions, and any other compensation to employees.
- Employee benefits that are not paid directly to the employee, I.e. healthcare, staff restaurant, or staff gym.
- Equipment that businesses purchase to make production and output more efficient.
- Rent or other mortgage payments required for the land the firm is using.
- Supplies that the firm requires in order to supply its output to consumers.
- Taxes and legal fees.
- Utilities that are required to keep the firm running such as electricity, water, and internet service.
Implicit Cost Examples
Whilst explicit costs have a specific value, implicit costs are not always so clear cut. For example, spending 5 hours playing video games means those 5 hours cannot be used for studying. The implicit cost is the hours that could have been used for studying instead. The value by which is not necessary monetarily quantifiable, but is still considered as a cost.
- Lost interest on funds occurs when the firm employs its capital, which means it foregoes the interest it could have earned in interest.
- Training a new employee presents an implicit cost in the fact that those seven hours could have been used doing other work.
- Going to University means that there is an implicit cost which is the money which could have been earned during that period.
- Maintenance means the firm has to stop production for a time which can lead to a lower level of output or dissatisfied customers.
Accounting and Economic Profit
In economics, there are two main types of costs for a firm. First are explicit costs. When looking at a firm’s financial statements, these costs are subtracted from the firm’s revenue to obtain its accounting profit. These explicit costs include employees’ wages, materials, utility bills, and rent.
Second of all, there are implicit costs, which is a factor in calculating the firm’s economic profit. This is simply the same as accounting profits, but also subtract the implicit costs. So the economic profit is calculated by obtaining the firm’s revenue and subtracting BOTH explicit and implicit costs.
FAQs on Explicit and Implicit Costs
An explicit cost is an absolute cost which is monetarily definable. In other words, it is clear that the firm has spend $x on Y. For example, employees wages, utility costs, and rent, are all examples of explicit costs. By contrast, an implicit cost is the cost of choose one option over another. For example, choosing not to work overtime means $x as an implicit cost as that income is foregone.
Lost interest on funds occurs when the firm employs its capital, which means it foregoes the interest it could have earnt in interest.
One such example of an explicit cost is the use of raw materials. The cost is explicit in the fact that the business has to make a direct payment has to its suppliers. That cost is very precise and can be easily calculated.
The difference between implicit and explicit costs is that explicit costs are clear and identifiable, whilst implicit costs purely refer to the opportunity cost.
Paul Boyce is an economics editor with over 10 years experience in the industry. Currently working as a consultant within the financial services sector, Paul is the CEO and chief editor of BoyceWire. He has written publications for FEE, the Mises Institute, and many others.