Implicit cost is the estimated opportunity cost of using resources in a particular way. It’s not an actual expense, but it’s still a real cost that affects business Trade decisions. For example, the implicit cost of hiring an employee might be the wages you would have had to pay someone else to do the same job.
There are two types of implicit costs:
- Monetary cost: This is the cash expense that is not directly related to the production of goods or services. For example, the wages paid to an employee are a monetary cost.
- Opportunity cost: This is the value of the next best alternative use of a resource. For example, if you own a factory and you hire a worker to produce widgets, the opportunity cost of that worker is what you would have had to pay to someone else to produce the same number of widgets.
Implicit costs can be significant factors in business decisions. For example, a company might decide not to expand its production capacity because the implicit costs of doing so are too high. Likewise, a company might decide to outsource some of its production to a foreign country because the implicit costs of doing so are lower.
Implicit costs are important to consider when making business decisions, but they should not be the only factor that is considered. Other factors such as sunk costs and externalities should also be taken into account.
Implicit Cost Formula
There is no one implicit cost formula, but the general idea is that you need to calculate the next best alternative use of a resource. For example, if you’re trying to calculate the opportunity cost of hiring an employee, you would look at what the next best alternative use of that employee’s time would be.
The best way to understand implicit cost is by example. Let’s say you own a factory and you’re hiring a worker to produce widgets. The wages you’re paying that worker are an implicit cost of producing widgets. But you could also think of the next best alternative use of that worker. Maybe the next best alternative use