Implicit Costs

Published Jan 1, 2023

Definition of Implicit Costs

Implicit costs are input costs that are not directly paid for but still have an economic impact. That means they are the costs that don’t require an actual cash payment by the company, like opportunity costs of using resources. They are the counterpart to explicit costs and together describe total costs.

Example

To illustrate this, let’s say that a small business owner, John, wants to expand his business. He has two options: he can either borrow money from a bank or use his own savings. If he borrows money from the bank, he will have to pay interest on the loan. Meanwhile, if he uses his own savings, he will not have to pay any interest.

But there is still a cost associated with using his own savings. That cost is the opportunity cost of not investing his money elsewhere. For example, if John were to invest his money in the stock market, he could historically earn a return of up to 7% annually on his investment. Thus, the implicit cost of using his own savings instead of the bank loan is the potential return he could have earned if he had invested his money elsewhere.

Why Implicit Costs Matter

Implicit costs are important to consider when making business decisions. They are often overlooked, but they can have a significant impact on the profitability of a business. That means it is important to take them into account when evaluating different options.