What is the difference between implicit cost and opportunity cost

Economic profits may be positive, zero, or negative. If economic profit is positive, other firms have an incentive to enter the market. If profit is zero, other firms have no incentive to enter or exit. When economic profit is zero, a firm is earning the same as it would if its resources were employed in the next best alternative. If the economic profit is negative, firms have the incentive to leave the market because their resources would be more profitable elsewhere.

The amount of economic profit a firm earns is largely dependent on the degree of market competition and the time span under consideration. In competitive markets, where there are many firms and no single firm can affect the price of a good or service, economic profit can differ in the short-run and in the long-run. In the short run, a firm can make an economic profit.

However, if there is economic profit, other firms will want to enter the market. If the market has no barriers to entry, new firms will enter, increase the supply of the commodity, and decrease the price. An economic profit of zero is also known as a normal profit. Despite earning an economic profit of zero, the firm may still be earning a positive accounting profit. Long-Run Profit for Perfect Competition : In the long run for a firm in a competitive market, there is zero economic profit.

Graphically, this is seen at the intersection of the price level with the minimum point of the average total cost ATC curve. Unlike competitive markets, uncompetitive markets — characterized by firms with market power or barriers to entry — can make positive economic profits. The reasons for the positive economic profit are barriers to entry, market power, and a lack of competition. Egalitarianism Definition Read More ». Explicit and Implicit Costs Definition.

Key Points An explicit cost is that which is clear and identifiable in monetary terms. An implicit cost is the cost of choosing one option over another. Accounting profit is revenue minus explicit costs, whilst economic profit is revenue minus explicit AND implicit costs. How to Calculate Implicit Cost Implicit costs are costs that occur due to a specific path or option being chosen.

Explicit Cost Examples An explicit cost is one that is a clear and obvious monetary amount made by the firm. Such examples include: Advertising and marketing costs. Employee wages, bonuses, commissions, and any other compensation to employees. Employee benefits that are not paid directly to the employee, I.

Equipment that businesses purchase to make production and output more efficient. Rent or other mortgage payments required for the land the firm is using. Supplies that the firm requires in order to supply its output to consumers. Taxes and legal fees. Utilities that are required to keep the firm running such as electricity, water, and internet service. Should the firm make the investment?

Show your work. Skip to content Chapter 7. Cost and Industry Structure. Learning Objectives By the end of this section, you will be able to:. Explain the difference between explicit costs and implicit costs Understand the relationship between cost and revenue. Calculating Implicit Costs Consider the following example.

Review Questions What are explicit and implicit costs? Would an interest payment on a loan to a firm be considered an explicit or implicit cost? What is the difference between accounting and economic profit? Glossary accounting profit total revenues minus explicit costs, including depreciation economic profit total revenues minus total costs explicit plus implicit costs explicit costs out-of-pocket costs for a firm, for example, payments for wages and salaries, rent, or materials firm an organization that combines inputs of labor, capital, land, and raw or finished component materials to produce outputs.

Previous: Introduction to Cost and Industry Structure. Next: 7. Share This Book Share on Twitter. Table 1. In corporate finance decisions, implicit costs should always be considered when deciding how to allocate company resources. Implicit costs are technically not incurred and cannot be measured accurately for accounting purposes.

There are no cash exchanges in the realization of implicit costs. But they are an important consideration because they help managers make effective decisions for the company. These expenses are a big contrast to explicit costs , the other broad categorization of business expenses. Explicit costs represent any costs involved in the payment of cash or another tangible resource by a company. Rent, salary, and other operating expenses are considered explicit costs. They are all recorded within a company's financial statements.

The main difference between the two types of costs is that implicit costs are opportunity costs, while explicit costs are expenses paid with a company's own tangible assets.

This makes implicit costs synonymous with imputed costs, while explicit costs are considered out-of-pocket expenses. Implicit costs are harder to measure than explicit ones, which makes implicit costs more subjective. Implicit costs help managers calculate overall economic profit, while explicit costs are used to calculate accounting profit and economic profit.

Examples of implicit costs include the loss of interest income on funds and the depreciation of machinery for a capital project. They may also be intangible costs that are not easily accounted for, including when an owner allocates time toward the maintenance of a company, rather than using those hours elsewhere.

In most cases, implicit costs are not recorded for accounting purposes. When a company hires a new employee, there are implicit costs to train that employee. If a manager allocates eight hours of an existing employee's day to teach this new team member, the implicit costs would be the existing employee's hourly wage, multiplied by eight.

This is because the hours could have been allocated toward the employee's current role. Another example of an implicit cost involves small business owners who may decide to pass on taking a salary in the early stages of operations to reduce costs and increase revenue. They provide the business with their skill in lieu of a salary, which becomes an implicit cost.