11/4/2008
A word about costs…
Explicit Costs: A direct payment for factors of
production.
Implicit Costs: (aka imputed costs) An indirect loss
associated with the use of a factor of production.
Introduction to
Production Costs
Explicit
versus
Implicit
Costs
Depreciation: The loss of an asset’s value due to
ware, obsolescence and the general passage of time.
Sunk Costs: Costs that have been incurred and
cannot be reversed, for example, spending on
advertising or research.
Theoretical Context It is important to note that explicit and
implicit costs are in fact both forms of opportunity costs.
Explicit Costs: A direct payment for factors of production. (If
you pay $1,000.00 for utilities, then the opportunity cost of the
utilities is the $1,000.00 cash that was given up.)
Implicit Costs: (aka imputed costs) An indirect loss
associated with the use of a factor of production. (If you use
equipment that you own, then the opportunity cost of that
equipment is whatever that equipment could have earned in
its next best application. For example, if you could have
rented the equipment for $800.00, then the implicit cost of
the equipment is $800.00.)
So you want an example?
Explicit Costs: stated, observable
• recorded on financial statements
You inherit a fast food restaurant from your parents. You have the
following resources: land: fast food restaurant (you own it)
labour: your skills as a short-order cook
capital: $50,000.00 cash
• arise from transactions between the firm and outside parties
You run the restaurant for a year, and then you assess your success:
• foregone opportunities associated with the purchase of resources
• paid directly in money
Accountant
Implicit costs: unstated, unobservable
• forgone opportunities associated with use of capital
Revenue:
Economist
$200,000.00
Expenses:
$24,000.00
Foregone wages:
Supplies
50,000.00
Wages
75,000.00
• not generally expressed within financial statements
Other
25,000.00
• costs associated with the use of the firm's own resources
Total Expenses
150,000.00
Net Income
$50,000.00
• not paid for directly in money
Foregone Rent:
35,000.00
Foregone interest:
1,000.00
Total Implicit Costs: $60,000.00
Accountant
is happy! ($50,000
accounting profit!)
Economist is sad!
($10,000.00
economic loss!)
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11/4/2008
Types of Profit
Accounting Profit: (aka Net Income) Revenue earned less
expenses incurred (including depreciation expense).
Economic Profit: Any accounting profit in excess of what a firm
could have earned if it had applied its exact same resources
toward their next best opportunities.
Normal Profit: (aka zero economic profit) Normal profit is what
a competitive firm can expect to earn in the long run. This is an
accounting profit that is exactly the same as the accounting
profit that could have been earned in the firm’s next best
opportunity. In other words, a firm will earn zero economic profit
in the long run.
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