Opportunity Cost

Connection between the distinctions of fixed vs. variable costs and opportunity costs

In economics, all costs are included whether or not they correspond to money payments. If we have opportunity costs with no corresponding money payments, they are called implicit costs. The implicit costs (as well as the money costs) are included in the cost analysis.

There is some correlation between implicit costs and fixed or variable costs, but this correlation will be different in such different kinds of firms as

A factory owned by an Absentee Investor

This is the easiest case to understand. All of the labor costs to the absentee investor are money costs, including the manager's salary. If the investor has borrowed some of the money he invested in the factory, then there are some money costs of the capital invested -- interest on the loan. However, we must consider the opportunity cost of invested capital as well. The investor's own money that he has used to buy the factory is money that she could have invested in some other business. The return she could have gotten on another investment is the opportunity cost of her own funds invested in the business. This is an implicit cost, and in this case the implicit cost is part of the cost of capital and probably a fixed cost.

A "Mom-and-Pop" Store

A "mom-and-pop" store (family proprietorship or partnership) is a store in which family members are self-employed and supply most of the labor. Typically, "Mom" and "Pop" don't pay themselves a salary -- they just take money from the till when they need it, since it is their property anyway. As a result, there are no money costs for their labor. But their labor has an opportunity cost -- the salary or wages they could make working similar hours in some other business -- and so, in this case, the implicit costs include a large component of variable labor costs.