Question

"Costs and Profit Maximization Under Competition", tells us that in deciding what quantity to produce, a firm should look at all its costs. We are reminded the "Total Cost" includes Opportunity Costs, not just money costs. Discuss the major costs that a business faces, being sure to distinguish between "Explicit Costs", and "Implicit Costs", using an example from a real or fictitious operating business.

Answer 1

Answer - The business in its functioning faces the costs which can be broadly classified into 2 main heading -

1 - Explicit cost

2 - implicit cost

Explicit costs are the costs which are incurred on the factors of production which are not owned by the owner of the business but need to be hired by the owner from outside. Hence the cost incurred in hiring the factors from outside is the explicit cost. These include the labor costs , cost of raw material etc.

Implicit cost are the cost which are incurred by the owner himself in the real terms or in the non monetary terms. These include the money or the capital the owner employes from his pocket and ofcourse the opportunity cost.

For example - There is a person X , who has a business of cloth manufacturing . He has employed the labor and the machinery in his business for the production process to be carried out. He has taken a loan from the bank. On the other hand he has also employed the capital from his own pocket. He prefers the production of the cotton cloth in the place of silk cloth.

Analysing this situation , we can conclude that the labor cost , cost of the machinery and the loan taken from the bank along with the interest will be considered as the explicit cost because these are the costs which are taken from the outsiders .

The capital which he employes from his own pocket are called the implicit cost. Also he also incur the opportunity cost . He incurs the opportunity cost when he chooses to produce the cotton in place of silk. The profit he would gain by producing silk will be his opportunity cost.