A large Modern Corporation

The corporation has relatively few implicit costs, but generally will have some. All labor costs will be expressed in money terms (though benefits and bonuses have to be included), since the shareholders don't supply labor to the corporation as "Mom and Pop" do in a family proprietorship. It will pay interest to bondholders and dividends to shareholders. But the dividends aren't really a cost item -- they include profits distributed to the shareholders. Moreover, the typical corporation will retain some profits and invest them within the business, a "plowback" investment. Conversely, shareholders may take a large part of their payout in appreciation of the stock value and plowback investment is one reason for the appreciation.

Thus we would say that the corporation has a net equity value, that is, that the corporation "owns" a certain amount of capital that it invests in its own business (very much like the absentee owner in the first example). This capital has an opportunity cost, and that opportunity cost is an implicit cost. The stockholders, who own the corporation, ultimately receive (as dividends or appreciation) both the opportunity cost of the equity

capital and any profit left over after it is taken out.

Unit Cost

Costs may be more meaningful if they are expressed on a per-unit basis, as averages per unit of output. In this way, we again distinguish

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.

Cost Analysis-I

Introduction to Cost

We can look at the business firm from at least two points of view: productivity, inputs, and outputs or outputs and costs. In advanced microeconomics, these two points of view are called "duals." They are equally valid, but they point up different things. They are also opposites from a certain point of view-- the higher the productivity, the lower the costs. By looking at the firm from the point of view of costs, we shift our perspective somewhat, and gain a much more direct understanding of supply.

We also look more directly at the difference between the long and short run. In the short run, we have two major categories of costs:

• Fixed Costs

• Variable Costs

In the long run, however, all costs are variable. Thus, we must study costs under two quite different headings. Costs will vary quite differently in the long run and in the short.

Fixed and Variable Cost 

Variable costs are costs that can be varied flexibly as conditions change. In the John Bates Clark model of the firm, labor costs are the variable costs. Fixed costs are the costs of the investment goods used by the firm, on the idea that these reflect a long-term commitment that can be recovered only by wearing them out in the production of goods and services for sale.

The idea here is that labor is a much more flexible resource than capital investment. People can change from one task to another flexibly (whether within the same firm or in a new job at another firm), while machinery tends to be designed for a very specific use. If it isn't used for that purpose, it can't produce anything at all. Thus, capital investment is much more of a commitment than hiring is. In the eighteen hundreds, when John Bates Clark was writing, this was pretty clearly true.