Economic Costs and Opportunity Cost in Firms

Study Notes

Economic Costs: Resources are scarce, productive, and have alternative uses. Using resources to produce one good means forgoing using them for other purposes.
Opportunity Cost: This is the measure of economic cost. It's the value that a resource would have in its best alternative use.
Explicit Costs: Monetary payments for resources owned by others. Explicit costs are revealed (cash expenditures). Examples: wages, materials, rent.
Implicit Costs: Opportunity costs of using self-owned or self-employed resources. Implicit costs are the forgone earnings from the best alternative use of these resources (not always obvious). For example, the income a business owner could earn elsewhere could be considered as an implicit cost.

A sales representative earning $22,000 per year decides to open a T-shirt retail store.
Investment of $20,000 savings that were earning $1,000 per year.
Rented a store (owned) for $5,000 per year.
Hired a clerk for $18,000 annually.

Total Sales Revenue: $120,000
Explicit Costs (Clerk's salary, Cost of T-shirts, Utilities): $63,000
Accounting Profit: $57,000
Implicit Costs (Foregone Interest, Foregone Rent, Foregone Wages, Foregone Entrepreneurial Income): $33,000
Economic Profit: $24,000

Normal profit is the minimum payment needed to keep an entrepreneur in a business. It is considered an implicit cost.
If an entrepreneur doesn't receive enough payment (less than normal profit) ,they might shift to a more profitable endeavor.

Economic Profit is total revenue less economic costs. This is the return above what's needed to retain entrepreneurial talent.
Economic profit is zero if total revenue just covers all explicit and implicit costs, including normal profit.

Accounting profit considers only explicit costs (payments to outside providers).
Economic profit takes into account both explicit and implicit costs (including the opportunity cost of resources the firm already owns).