Question

When analyzing a firm’s behavior, it is important to include all the opportunity costs of production” Discuss this statement by providing examples for ALL costs. What does this imply for the type of profit the firm will adopt?

Answer 1

Ans) Explicit cost is the cost that is made directly. It has dollar value attached to it. Eg- cost of machinery, rent etc.

Implicit costs are the opportunity cost that firms make while making a decision. It is not reported separately. Eg- firms using its own resources like its own building for which it does not pay any rent. Leaving one product to manufacture other etc.

Accounting profit includes only explicit cost.

Accounting profit = total revenue - explicit cost.

Economic profit includes both implicit and explicit cost.

Economic profit = total revenue - total (explicit cost + implicit cost)

When analysing a firm's behaviour, it becomes important to take into account the implicit costs as well i.e opportunity cost. It will then show why a firm behaves in a particular manner. A firm choose to take any decision after weighing all the opportunity cost as well as explicit costs.

This implies that firm will calculate economic profit.