Explicit versus Implicit Costs

Consumers typically think of cost as the amount paid when buying something. However, economists define cost as the value of resources given up in order to produce a good or service. For instance, the time it takes to do something represents a cost. There is also opportunity cost—the cost of giving up the next best alternative. If two opportunities are mutually exclusive, meaning a person can only choose one of these opportunities, one opportunity cannot be pursued. Giving up this opportunity is part of the cost of something.

A cost involving monetary payment is known as an explicit cost. These costs have a definite, readily identifiable value. Employee wages, utilities, and equipment are all examples of explicit costs. Even bartered goods and services are considered explicit costs, because they have a specific monetary worth.

An implicit cost is the opportunity cost that occurs from allocation of resources for a specific purpose, which cannot easily be assigned a monetary value. Business expenses that cannot be assigned to any specific good or service are also implicit costs. For instance, the time required to train a new employee is an implicit cost. Maintenance activities such as taking a robot offline for routine service are also implicit costs. Many opportunity costs are implicit costs—the cost of giving up the next best alternative. For example, a company that makes household appliances might make a choice about how to spend available money. The company might choose not to invest the money in producing refrigerators but instead spend the money investing in employee training. When the company gives up the opportunity to make money by producing and selling refrigerators, this is part of the cost of investing in employee training. Similarly, if a person decides to start a business, she might make a decision about her income. If she gives up the chance to earn a salary at another firm, choosing instead to work for her own company, the salary she gives up is a cost.