Question

Definition of economic costs Dmitri lives in Philadelphia and runs a business that sells guitars. In an average year, he receives $851,000 from selling guitars. Of this sales revenue, he must pay the manufacturer a wholesale cost of $476,000; he also pays wages and utility bills totaling $281,000. He owns his showroom; if he chooses to rent it out, he will receive $71,000 in rent per year. Assume that the value of this showroom does not depreciate over the year. Also, if Dmitri does not operate this guitar business, he can work as an accountant, receive an annual salary of $34,000 with no additional monetary costs, and rent out his showroom at the $71,000 per year rate. No other costs are incurred in running this guitar business. Identify each of Dmitri's costs in the following table as either an implicit cost or an explicit cost of selling guitars. Implicit Cost Explicit Cost The rental income Dmitri could receive if he chose to rent out his showroom The wholesale cost for the guitars that Dmitri pays the manufacturer The salary Dmitri could earn if he worked as an accountant The wages and utility bills that Dmitri pays

Answer 1

Implicit Cost Explicit Cost The rental income Dmitri could receive if he chose to rent out his showroom Implicit cost The wholesale cost for the guitars that Dmitri pays the manufacturer Explicit cost The salary Dmitri could earn if he worked as an accountant Implicit cost The wages and utility bills that Dmitri pays Explicit cost.

What is implicit cost?

An implicit cost is a cost that is not paid in cash, but rather represents an opportunity cost or a foregone alternative. In this case, the rental income Dmitri could receive if he chose to rent out his showroom and the salary Dmitri could earn if he worked as an accountant are both implicit costs because they represent the opportunity cost of running the guitar business instead of engaging in these other activities.

What is explicit cost?

An explicit cost is a cost that is paid in cash and is directly incurred as a result of engaging in a particular activity. In this case, the wholesale cost for the guitars that Dmitri pays the manufacturer and the wages and utility bills that Dmitri pays are both explicit costs because they are directly incurred as a result of running the guitar business.

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Answer 2

Explicit Cost Implicit Cost Dmitri's potential rental revenue if he opted to rent out his showroom Implicit cost Dmitri pays the manufacturer's wholesale price for the guitars. Dmitri's potential salary as an accountant Implicit cost The salary and electricity bills that Dmitri pays have an explicit cost.

What is the difference between implicit and explicit costs?

• An implicit cost is one that is not paid in cash but rather symbolizes a missed opportunity or a foregone alternative. In this case, the rental income Dmitri could earn if he chose to rent out his showroom and the salary Dmitri could earn if he chose to work as an accountant is both implicit costs because they represent the opportunity cost of running the guitar business rather than engaging in these other activities.
• An explicit cost is one that is paid in cash and is incurred directly as a result of engaging in a certain activity. In this scenario, the wholesale cost of the guitars paid to the manufacturer, as well as Dmitri's salaries and electricity bills, are both explicit expenses because they are directly incurred as a result of running the guitar company.

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