Implicit & Explicit Costs in Economics

Economics is the study of transactions between producers and consumers with limited resources. Because the money used to produce one product could have been used to produce something else, each transaction involves an economic cost of implicit and explicit value to both buyer and seller. Explicit costs include the exchange of money for a good or service. The implicit cost refers to the tangible costs for which no money is exchanged. Economists count the implicit and explicit costs together when determining the value of a thing.

Labor

The wages, bonuses and cost of benefits for employees are explicit costs. These costs are calculable monetary costs. An employer can anticipate the amount of explicit labor costs over a set period of time. The implicit costs of labor include hiring one worker over another who may be a better worker but does not have the better application. Companies may also pay an implicit cost in some industries for choosing to utilize workers over machines.

Resources

The limited nature of resources requires consumers and producers to choose one thing over another when making purchases or deciding to manufacture a product. The limited nature of the resource is often indicated in the monetary price of the resource. Producers must weigh whether the explicit cost of the raw material is worth paying to produce a product. Likewise, consumers must decide whether they will pay the final price of the product, which included the price the producer paid for the raw material. Since money is also a limited resource, producers choose to pay the price of the resource over spending the money on something else. The value of the something else that was not purchased is the implicit cost of resources.

Incalculable Costs

A business owner may use his own unpaid time to grow his business. In addition, he may use resources already in his possession, such as a warehouse or land, which he does not have to pay any money to obtain. The value of these items are implicit costs. Multiple companies owned by a single entity may share services and facilities without charge. The use of services and facilities without charge is also an implicit cost. The law requires businesses to keep track of implicit costs that are incurred from sharing between two or more subsidiaries of a single company. The practice is called "transfer pricing."

Calculating Profit

Economists regard profit differently than accountants. Accountants calculate profit by subtracting total monetary outlays, or explicit costs, from the total revenue. Economists start by placing a monetary value on services rendered or land held in possession though no payment was made. These implicit costs are added to the total explicit costs to achieve the sum economic cost. The total economic cost is subtracted from the total revenue to assess total profit.