Explicit Vs Implicit Cost

Costs borne by a firm can fall into two categories: explicit and implicit. According to “Principles of Economics”, explicit costs are monies that are paid out in order to run the business and may include such things as wages or rent; while implicit costs “represent the opportunity cost of using resources already owned by the firm.” (OpenStax, 2014, p. 159). My husband and I operate a small business which is a martial arts school. At this company we have explicit costs, our largest explicit costs each month are rent and utilities. We also experience implicit costs in this business, primarily my husband’s time – since the business is just getting rolling he does not pay himself a salary, and so the opportunity cost of the time he spends working …show more content…
Principles of Economics describes the difference as “Accounting profit is … total revenue minus explicit costs … [whereas] Economic profit is total revenue minus total cost, including both explicit and implicit costs.” (OpenStax, 2014, p. 159). Building on the examples above, in our martial arts business, we pay taxes on any accounting profits which our bookkeeper calculates as revenue minus the expenses on the books; while our economic profit would be calculated as the difference between the same revenue and the combination of both the recorded expenses and the missed-opportunity expenses of my husband’s valuable time. In the factory example, it is a little more difficult to realize the difference between accounting and economic profit, because over time the ‘hidden factory costs’ that should (by definition) only be a factor in the economic profit calculation, actually do affect the bottom line and change the accounting profit picture. For example, if a factory needs to rework or even scrap and remanufacture a high percentage of their production, the firm needs to over-work both its equipment and its personnel. This over-working can translate directly into higher explicit costs in terms of more frequent machine repairs, in overtime pay, and even greater than expected replacement costs for both burnt-out equipment and burnt-out …show more content…
This can be a delicate balance. Economy of scale is a concept based on the effect of the cost per unit going down as the output (quantity produced) increases. Economies of scale are true up to a certain point for each firm, a point beyond which a company may begin to experience the opposite effect, called diseconomies of scale. In diseconomies of scale, “as the level of output and the scale rises, average costs rise as well.” (OpenStax, 2014, p. 170). “Once a firm has determined the least costly production technology, it can consider the optimal scale of production, or quantity of output to produce.” (OpenStax, 2014, p. 167). Returning again to the example of a martial arts school, an economy of scale is realized as more students are enrolled in a given class. The costs for running a class are relatively fixed – the rent, the utility usage, and the instructor’s time are fixed costs. The students pay to take classes, so the more students in a class the higher the revenue generated for that class. This logically means that a class with 20 students generates 10 times the revenue of a class with only 2 students. There is an optimal class size however, beyond which the school will begin to experience diseconomies of scale. As class sizes grow, students can feel they are getting less value from the lessons because the instructor gives them less personal attention and