It's critical to understand the difference between implicit and explicit costs, especially in the context of opportunity costs.
What's the Difference Between Implicit and Explicit Costs?
They're two separate costs, that sum together to comprise opportunity cost.
Explicit Costs: The Obvious Ones
An explicit cost is a direct, out-of-pocket expense that's easily measurable and identifiable.
Think of explicit costs as the "visible" expenses you encounter.
Examples of Explicit Costs
Some easy examples include...
- Paying $5 for a cup of coffee
- Spending $1000 on rent each month
- Buying a new laptop for $800
- Paying an employee a $50,000 annual salary
Implicit Costs: The Hidden Players
An implicit cost is the value of the next best alternative that you give up when making a choice.
Implicit costs are trickier to spot. They're the "invisible" costs that don't directly impact your bank account but still affect your overall economic situation.
Examples of Implicit Costs
Some easy examples include...
- The salary you forgo by choosing to study full-time instead of working
- The potential rental income lost by living in your own house instead of renting it out
- The time you spend volunteering instead of working a paid job
- The interest you miss out on by keeping cash at home instead of in a savings account
How to Identify Implicit vs. Explicit Costs
In essence: if the cost is a direct monetary transaction from an action you're choosing to take... it's an explicit cost.
If the cost is associated with the next-best alternative that you passed up... it's an implicit cost.
#1 Mistake When Dealing with Implicit vs. Explicit Costs
Just because a cost has a dollar amount associated with it, doesn't guarantee it's explicit!
Example: You pass up a $75,000 salary to go become an actor in Hollywood.
While there's the $75,000 associated with the next-best alternative... it's still implicit!
On the flip side: just because a cost doesn't have a dollar amount associated with it, doesn't guarantee it's implicit!
Example: You pay a monthly gym membership fee.
While we're not given the cost of the gym membership, we can assume it has a direct monetary value. Therefore, it's explicit!
