Total+cost+including+implicit+and+explicit+costs

Total cost is the sum of variable and fixed costs. As implied by the name, fixed costs do not change based on output levels. They are costs such as depreciation while variable costs fluctuacte, or vary, based on the activity within the company. Total opportunity cost is comprised of both Explicit costs and Implicit costs. Explicit costs are often referred to as accounting costs; these are the more obvious costs. An example of an explicit cost is the cost of producing a good including parts, labor, and overhead. Implicit costs are the cost of foregoing the next-best alternative use of the resource. For example, the factory that is used to produce a product (i.e. wooden tables) could be used to produce another item (i.e. metal cabinets). Both of these costs combined make up opportunity cost; therefore, the opportunity cost of producing a good (explicit and implicit costs) is more than the accounting cost (explicit costs).

Implicit costs are difficult to measure or quantify. Because of this, they are often overlooked when analyzing results and making decisions. Implicit costs are actual costs to a company and should be measured and used during decision making processes. Implicit costs can be siginficant amounts and could alter a business decision. Managers can utilize internal resources of their company including the finance, marketing, and legal departments to help identify and measure implicit costs.

The following is an example of explicit and implicit costs. Farmer A can either plant and harvest a field or rent the field to another farmer (Farmer B). The explicit costs for Farmer A if he plants the field are the cost of seed, fertilizer, and gasoline for the farm equipment. The implicit costs for Farmer A are the foregone rental income from Farmer B and the opportunity cost of Farmer A's time (what he could have earned had he not been planting the field).

Total cost including implicit and explicit costs are often used in the real world as a benchmark regarding whether a business should continue to operate, change their operations or potentially shut down. A business might choose to cease operations for several reasons. If total revenues do not cover total costs, the business is losing money. A decision might be made to shut down operations in the short or long run depending on whether or not they are covering their fixed costs. If they fail to cover fixed costs, they should cease operations immediately. If they are covering their fixed costs but not their variable costs, they should potentially shut down in the long run. A business might also change their operations if the opportunity cost (combination of expicit and implicit cost) exceeds total revenue. If current resources being used can be better utilized by a business, the total opportunity cost will show it.

Multiple Choice:

1) When making a decision, the alternative that proves to be the best alternative choice to the decision made is an example of:

A. Total Cost B. Implicit Cost C. Opportunity Cost D. Explicit Cost

2) The price one pays for a DVD is an example of ______________ cost, whereas the______________ cost of passing up the next best alternative is represented by a VHS tape.

A. Opportunity, Explicit B. Explicit, Implicit C. Implicit, Opportunity D. Explicit, Implicit

3) True or False: Implicit costs are easy to identify while explicit costs are usually overlooked or ignored.

4) True or False: Opportunity costs are the difference between economic profits and the explicit costs.

Answers: B, D, False, False

Source: Managerial Economics and Business Strategy, by Michael Baye