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Definition:

Economic cost refers to the total value (cost) invested by the entrepreneur for an economic or business activity. It is the total cost of a firm to produce its goods. Economic activity might include; staring a business, buying and selling of goods or services, decision making cost, etc. Economic cost includes monetary values as well as other values, like resources and satisfaction.

Types:

Economic cost of a business is split up into the following types:

  • Explicit cost
  • Implicit cost
  • Real cost
  • Opportunity cost

(1) Explicit Cost – Definition and Example:

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.

Example:

The explicit cost includes wages and salary payments, expenses on the purchase of raw material, light, fuel, advertisements, transportation, taxes and depreciation charges.

(2) Implicit Cost – Definition and Example:

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”.

Example:

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.

(3) Real Cost – Definition:

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 economists.

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 of prices.

(4) Opportunity Cost – Definition and Example:

The concept of opportunity cost has a very important place in economic analysis. It is defined as:

“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”.

Example:

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 per month. 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 per month.

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.