Implicit costs are defined by economists as nonmonetary opportunity costs. Why i
ID: 1224708 • Letter: I
Question
Implicit costs are defined by economists as nonmonetary opportunity costs. Why is it important for a firm to take these costs into consideration when evaluating a potential activity, when they don't involve any monetary expense? Consider the following two taxes: 1) a state imposes a 10 cent tax on every gallon of gasoline sold in the state to pay for road maintenance and improvements, and 2) a state imposes an additional 1% income tax on all state residents to pay for the construction of 50 new soccer fields throughout the state. Which of these two taxes is more consistent with the benefits-received principle? Why?Explanation / Answer
Q1.
Implicit costs refer to the cost of owner-supplied resources. In other words, it is the value of resources that are owned by the business firm owner and are supplied to business firm for productive purpose. For example, cost pertaining to labor, land or any other factor that business owner supply is implied cost.
Even though there is no monetary payment is made in exchange for them, however, if they are not been utilized in business itself they would be utilized somewhere else and thus would be earning something. This estimated earning is considered their implied cost.
Thus, implied cost indicates the opportunity cost of utilizing a factor.
It is important for a firm to take these costs into consideration when evaluating a potential activity even when such costs do not involve reciprocal monetary expense because these costs symbolize the return that could be earned by utilizing the factors (underlined by these costs) somewhere else rather than in the potential activity.
If return from potential activity are such that they are not sufficient enough to recover the implicit cost then this implies that factors (underlined by implicit cost) are better-off being utilized somewhere else as such utilization will generate better return.
Their continuous use in potential activity will only create and widens the economic loss.
In economic terms, it is not the accounting profit but the economic profit that determines the sustenance of business. So, economic loss due to non-recovery of implicit cost will point towards lack of sustainability of business and its eventual failure.
Thus, even though implicit cost does not involve any monetary cost then also their consideration determine the sustainability of business and rightful utilization of factors of production supplied by business owner.
Their non-consideration will not reflect the true picture of potential activity and thus result in unprofitable decision-making.