Let's dive into implicit costs: a.k.a. the hidden costs of every decision you make!
What are Implicit Costs?
An implicit cost is the value of forgone option you choose not to take.
In simpler terms - what do you give up by choosing one option over another? This is commonly referred to as the "next best alternative".
Examples of Implicit Costs
Let's look at some everyday examples:
- You use your car for a food delivery side hustle instead of renting it out for $1k a month
- A small business owner works in their shop instead of taking a $75k job elsewhere
- You spend time studying instead of working a part-time job
- A farmer uses land to grow crops instead of selling or renting it out
- You use your savings to start a business instead of keeping it in an 3% interest-earning account
It's the "instead of..." that makes these bold items implicit costs! We're forgoing these options, and therefore we miss out on their value.
How to Spot Implicit Costs
To identify an implicit cost, simply ask yourself: am I forgoing this option in favor of something else?
The #1 Mistake People Make with Implicit Costs
Many people focus solely on explicit costs (the ones that involve actual money leaving their pocket) and forget about implicit costs.
But when considering opportunity cost, implicit costs are included.
Example: A student might think studying is "free", forgetting that their time could have been spent earning money at a part-time job.
Explicit Costs vs. Implicit Costs
Explicit costs are direct, out-of-pocket expenses.
They involve actual payments to other parties. Think of rent, salaries, or the cost of materials.
Implicit costs, on the other hand, don't involve direct payments. They're the "what-ifs" - the value of the next-best alternative you gave up.
Opportunity Cost vs. Implicit Cost
Opportunity cost combines both explicit + implicit costs. It's the true cost of an action.
Implicit cost is not opportunity cost - because it does not include the chosen action and its monetary value (explicit cost).
