Cost Analysis-II

Explicit Costs and Implicit Costs

Economists have classified types of costs as explicit (accounting) costs, and implicit costs. Explicit costs are out of pocket, obvious kinds of costs, e.g., expenses on books, tuition, as, etc. Implicit costs are not really expenses you incur, but involve income or values you are giving up by not doing something that you could have chosen to do. For instance, if you decide to go to school full time instead of working a $20,000 job, you are giving up earning $20,000. This is your implicit cost.

Accounting vs. Economic Costs

Accountants have been primarily concerned with measuring costs for financial reporting purposes. As a result, they define and measure cost by the historical outlay of funds that takes place in the exchange or transformation of a resource. 

Economists have been mainly concerned with measuring costs for decision-making purposes. The objective is to determine the present and future costs (or resources) associated with various alternative courses of action.

In calculating the cost to the firm of producing a given quantity of output, economists include some additional costs that are typically not reflected in financial reports. 

• Explicit cost are considered by both groups

• Implicit costs are considered by economists:

a. Opportunity cost of time

b. Opportunity cost of capital

Economic Profit = Tot Rev - Exp Cost - Imp Cost

Accounting versus Economic Profits

To calculate accounting and economic profits we need to know the company’s total revenue. Let’s suppose it is $140,000. Then, accounting profits are: total revenue minus explicit costs or: $140,000 - $113,000 = $27,000. Economic profits are: total revenue minus total economic costs or; $140,000 - $150,000 = -$10,000 (i.e. a loss of $10,000). The above firm reaps a positive accounting profit; but the negative economic profit indicates that from an economic point of view, the owner should discontinue the operation.

Cost Calculations

Using the above abbreviations and Q for the quantity of output:

ATC = TC/Q

AFC = TFC/Q

AVC = TVC/Q

MC = change in TC/change in Q