Concept of Economic Costs:
We have discussed the important
types of cost which a firm has to face. The
cost of production
from the point of view of an individual firm is split up into
the following parts.
Explicit cost is also called
money cost or accounting cost. Explicit cost
represents all such expenditure which are incurred by an
entrepreneur to pay for the hired services of factors of
production and in buying goods and services directly. In other
words, we can say that they are the expenses which the business
manager must take into account of because they must actually be
paid by the firm.
The explicit cost includes wages and
salary payments, expenses on the purchase of raw material,
light, fuel, advertisements, transportation, taxes and
The implicit costs are the
imputed value of the entrepreneur's own resources and services. Implicit costs can be defined as:
"Expenses that an
entrepreneur does not have to pay out of his own pocket but are
costs to the firm because they represent an opportunity cost".
For instance, if a person is working
as a manager in his own firm or has invested his own capital or
has built the factory at his own land, the reward of all these
factors of production at least equal to their transfer prices
is, included in the expenses of a business.
Implicit costs, thus, are the
alternative costs of the self-owned and self-employed resources
of a firm. The total costs of a business enterprise is the sum
total of explicit and implicit costs. If the implicit costs are
not included in the firm's total cost, the cost of the firm will
be understated and it will result in serious error.
Real costs are the pains and
inconveniences experienced by labor to produce a commodity.
These costs are not taken in the costing of a commodity by the
firm. Real cost has been defined differently by different
Classical economists understood by
real costs the pains and sacrifices of labor. Alfred Marshall
calls real cost as social cost and describes it:
"Real costs of efforts of various
qualities and real costs of waiting".
The Austrian School of Economists
have criticized the meaning given to real cost by the classical
economists and new classical economists. They say that to give a
subjective value to cost is a hopeless task as when real cost is
expressed in terms of sacrifices or pains, it is not amenable to
precise measurement and thus it fails to explain the phenomenon
The concept of opportunity cost
has a very important place in economic analysis. It is defined
"The value of a resource in its next best use. It is the
amount of income or yield that could have been earned by
investing in the next best alternative".
The opportunity cost
of a good can be given a money value. For instance, a labor is
working in a factory and is getting $2000 P.M. The entrepreneur
is paying him this amount because he can earn this amount in the
next best alternative employment. If he pays less than this
amount, he will move to next best alternative occupation, where
he can get $2000 P.M.
So in order to obtain a productive service
say labor in the present occupation, the cost should be equal to
the amount which he can get in some alternative occupation.
Similarly, a piece of land or capital must be paid as much as
they could earn in their next best alternative use. The total
alternative earnings of the various factors employed in the
production of a good constitute the opportunity cost of a good.
In a money economy, opportunity or transfer cost is defined as
the amount of money which a firm must make to resource suppliers
m order to attract these resources away from alternative lines
of production. In the words of Lipsay:
"The opportunity cost of using any
factor is what is currently foregone by using it".
The idea of opportunity cost has an
important bearing on the decisions involving scarcity of
resources, their alternative uses and the choice.