<p>Nicholson defines economic costs as: &quot;The economic cost of any input is the payment required to keep that input in its present employment. Equivalently, the economic cost of an input is the remuneration the input would receive in its best alternative employment.&quot;.</p>
<p>Here, Economic Costs = Explicit + Implicit Costs, and he also says that Implicit Costs are: &quot;implicit cost of the machine to be what someone else would be willing to pay for its use. Thus, the cost of one machine-hour is the rental rate for that machine in its best alternative use. By continuing to use the machine itself, the firm is implicitly forgoing what someone else would be willing to pay to use it.&quot; (Microeconomic Theory, p. 333-334)</p>
<p>So this is how it's defined by Nicholson.
In competitive markets, profit maximization by firms leads to the real remuneration of inputs to be equal to it's marginal productivity (and nominal remuneration to be marginal productivity times the product's price). Since the real remuneration equals the economic costs of the input, we know that economic costs equals the marginal productivity of said input. So the value of &quot;the best forgone alternative&quot; is simply the marginal productivity of the input in the best possible allocation, and nominal economic costs would be the marginal revenue generated by that input.</p>
<p>Consider this: In profit maximization, we know that:
<span class="math-container">$$MgPK.P \ = \ r$$</span>
Where, MgPK is the marginal product of capital. Since r is the economic cost of capital, dividing it between implicit and explicit costs gives:
<span class="math-container">$$MgPK.P \ = E + I\\MgPK.P \ - \ E \ = \ I$$</span>
So Implicit Costs equals the marginal revenue generated by capital minus its explicit costs. So, to answer your question, we could think of implicit costs as the marginal revenue of capital minus explicit costs in the best possible allocation of capital. If you suppose Explicit Costs = 0 (which just means that there are no costs of running the machine directly), then Implicit Costs are simply the marginal revenue of capital in the best possible allocation, and real implicit costs are the marginal productivity in that allocation.</p>
<p>Bear in mind that there is a gigantic general equilibrium discussion here. In general equilibrium, all possibilities of economic profits should be exhausted and the marginal revenue of every input should be exactly the same in every possible allocation (since, if this weren't  the case, there would be a reallocation possibility that generates profits). Consequently, marginal revenue should be equal in every allocation and economic costs would be exactly equal to this constant marginal revenue.</p>
<p>Hope this helps and answers the question. If there are still any questions or any mistakes in my answer, I am open to continuing the discussion. :)</p>

CC BY-SA 4.0
2024-10-18T09:31:20.327Z
2024-10-18T09:31:20.327Z
zzaeg
<p>Economic profit is defined as:</p>
<p><span class="math-container">$$ \text{Economic Profit} = \text{Revenue} - (\text{Explicit Costs} + \text{Implicit Costs}) $$</span></p>
<p>But what exactly is implicit cost defined as?</p>
<p>I understand it as: <em>The <strong>value</strong> of the best (i.e. most valuable) foregone alternative</em>.</p>
<p>...But <strong>how do we define this value</strong>?</p>
<p>Is it the <strong>accounting profit</strong> of that alternative? (i.e the gain of that alternative minus the explicit cost of that alternative)</p>

<profits>
Understanding Implicit Cost in Economic Profit Calculation
LearningAboutTheWorld
# Understanding Implicit Cost in Economic Profit Calculation

(Asked by: username_0 on 2024-10-17)

Economic profit is defined as:

$$ \text{Economic Profit} = \text{Revenue} - (\text{Explicit Costs} + \text{Implicit Costs}) $$

But what exactly is implicit cost defined as?

I understand it as: *The **value** of the best (i.e. most valuable) foregone alternative*.

...But **how do we define this value**?

Is it the **accounting profit** of that alternative? (i.e the gain of that alternative minus the explicit cost of that alternative)

**Tags:** profits


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## 1 answers

### Answer by username_1 on 2024-10-18. Score: 1

Nicholson defines economic costs as: "The economic cost of any input is the payment required to keep that input in its present employment. Equivalently, the economic cost of an input is the remuneration the input would receive in its best alternative employment.".

Here, Economic Costs = Explicit + Implicit Costs, and he also says that Implicit Costs are: "implicit cost of the machine to be what someone else would be willing to pay for its use. Thus, the cost of one machine-hour is the rental rate for that machine in its best alternative use. By continuing to use the machine itself, the firm is implicitly forgoing what someone else would be willing to pay to use it." (Microeconomic Theory, p. 333-334)

So this is how it's defined by Nicholson.
In competitive markets, profit maximization by firms leads to the real remuneration of inputs to be equal to it's marginal productivity (and nominal remuneration to be marginal productivity times the product's price). Since the real remuneration equals the economic costs of the input, we know that economic costs equals the marginal productivity of said input. So the value of "the best forgone alternative" is simply the marginal productivity of the input in the best possible allocation, and nominal economic costs would be the marginal revenue generated by that input.

Consider this: In profit maximization, we know that:
$$MgPK.P \ = \ r$$
Where, MgPK is the marginal product of capital. Since r is the economic cost of capital, dividing it between implicit and explicit costs gives:
$$MgPK.P \ = E + I\\MgPK.P \ - \ E \ = \ I$$
So Implicit Costs equals the marginal revenue generated by capital minus its explicit costs. So, to answer your question, we could think of implicit costs as the marginal revenue of capital minus explicit costs in the best possible allocation of capital. If you suppose Explicit Costs = 0 (which just means that there are no costs of running the machine directly), then Implicit Costs are simply the marginal revenue of capital in the best possible allocation, and real implicit costs are the marginal productivity in that allocation.

Bear in mind that there is a gigantic general equilibrium discussion here. In general equilibrium, all possibilities of economic profits should be exhausted and the marginal revenue of every input should be exactly the same in every possible allocation (since, if this weren't the case, there would be a reallocation possibility that generates profits). Consequently, marginal revenue should be equal in every allocation and economic costs would be exactly equal to this constant marginal revenue.

Hope this helps and answers the question. If there are still any questions or any mistakes in my answer, I am open to continuing the discussion. :)


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