Explicit vs. Implicit Cost

What Is Explicit vs. Implicit Cost?

Explicit and implicit costs are the two components of a resource's full economic cost. An explicit cost is a direct, out-of-pocket monetary payment made for a resource, such as rent, wages, or materials, the kind of cost that appears in accounting records. An implicit cost is the value of the best forgone alternative use of a resource the owner already has, with no cash changing hands. For example, an entrepreneur who works in her own business without drawing a salary incurs the implicit cost of the wages she could have earned elsewhere. Together, explicit and implicit costs capture the true opportunity cost of every resource a decision uses.

Why It Matters

The explicit-implicit distinction is what separates economic thinking from ordinary accounting. Accountants typically record only explicit costs, so accounting profit counts just the cash paid out. Economists insist on including implicit costs as well, because ignoring forgone alternatives understates the real cost of a decision. This is why economic profit equals total revenue minus both explicit and implicit costs, and why a firm earning zero economic profit, known as normal profit, is still fully covering the opportunity cost of its owners' resources and doing as well as its next-best option. Recognizing implicit costs changes real choices: it reveals when a seemingly profitable venture is actually losing money once the value of the owner's time and capital is counted.

Test Your Knowledge

Questions on this topic from the EconRecall fact bank:

• How do economists calculate economic profit?
  Total revenue minus both explicit and implicit costs
• What does it mean when economists say a firm is earning "normal profit"?
  Its economic profit is zero — revenues just cover all explicit and implicit costs