Explicit Costs
What is Explicit Costs?
Explicit Costs are direct, out-of-pocket payments made by a firm for inputs purchased from others.
These include wages, rent, and raw material expenses that involve actual cash transactions and are recorded in accounting records. They are part of both accounting and economic profit calculations.
Explicit Costs: a worked example
Maya runs a print shop. Over one year she pays $62,000 in wages to two employees, $24,000 in shop rent, $31,000 for paper and ink, and $7,000 for utilities and insurance. Summing the four payments gives explicit costs of $124,000, every dollar of which left her bank account and appears on a receipt. Sales revenue is $168,000, so the profit on her books is $168,000 minus $124,000, which is $44,000. Maya also gave up a $52,000 salary at her old job. That sacrifice is implicit and never belongs inside the $124,000 total, but it is subtracted afterward: $44,000 minus $52,000 leaves an economic loss of $8,000. The exam skill is sorting the list, since a cost is explicit only when money actually leaves the firm to pay for an input.
The mistake students make with explicit costs
Students often drag the owner's forgone salary or the interest given up on invested savings into the explicit column, because those sacrifices feel every bit as real as a rent check. Explicit costs require money actually leaving the firm and going to somebody else, backed by an invoice or a paycheck. Keep forgone earnings in the implicit column, subtract explicit costs alone to reach accounting profit, then subtract implicit costs to reach economic profit. Counting one item in both columns is the fastest way to lose the point.
Explicit Costs questions
Are explicit costs the same as accounting costs?
Explicit costs and accounting costs describe the same payments: wages, rent, materials, utilities, and interest paid on a bank loan. Accountants track them because each one has a document attached. Economists use that identical list and then add implicit costs on top, which is why economic profit for a given firm is always less than or equal to accounting profit.
Does an owner's salary count as an explicit cost?
The owner's salary counts as an explicit cost only when the business actually writes the owner a paycheck, since money then leaves the firm and gets recorded. If the owner works unpaid and simply keeps whatever revenue is left over, the salary given up at the next-best job is an implicit cost instead. Both figures matter for economic profit, but only the paid version reaches the accounting records.
How do explicit costs affect economic profit?
Explicit costs get subtracted first, then implicit costs, because economic profit equals revenue minus explicit costs minus implicit costs. A firm with $200,000 of revenue, $150,000 of explicit costs, and $40,000 of implicit costs earns $10,000 of economic profit. Since explicit costs sit inside both profit measures, a wage increase or a rent increase lowers accounting profit and economic profit by exactly the same amount.
Related terms
Common comparisons
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