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Explicit and implicit costs, for unit 5, www.inflateyourmind.com by John Bouman. - YouTube
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Hello and welcome to Unit 5, where we're going聽
to talk about all kinds of different costs,聽聽
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economic costs. Here let's start distinguishing聽
between explicit and implicit costs. Explicit聽聽
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costs are out-of-pocket or visible expenses,聽
so if you're running a business, these are the聽聽
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things that you pull your checkbook out for, and聽
you actually make visible payments. For example,聽聽
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if you have to pay wages to workers, if you have聽
to pay rent, if you have to buy office supplies or聽聽
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raw materials or any other ingredients to make聽
your business run, you write a check to other聽聽
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people, and those are called explicit costs, or聽
explicit expenses. Implicit costs, or implicit聽聽
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expenses, are non-visible costs, sometimes also聽
called opportunity costs. So these are not really聽聽
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out-of-pocket expenses and you don't really see聽
them, but in economics, we say that, for example,聽聽
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if you own your own building while you're running聽
your business operation, there is not really any聽聽
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rent that you pay to anyone, because you own the聽
building. But if you had not run your business,聽聽
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you could have earned income, rent, by renting聽
out the building, so there's an implicit or a聽聽
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sacrificed expense, in this case. In accounting,聽
the only expenses that the accountant takes into聽聽
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account to calculate, for example, the amount聽
of taxes owed, are the explicit costs. But in聽聽
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economics, because we deal with decision making,聽
whether we should expand the business whether聽聽
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we should continue to run the business or whether聽
we should shut down the business, we have to take聽聽
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both explicit and implicit costs into account. The聽
sum of explicit and implicit costs is what we call聽聽
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total economic costs. So let's take a look at an聽
example here that a typical business might face.聽聽
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So we have, first of all, wages to employees. So聽
let's say that the business each month pays $6,000聽聽
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in wages to employees. Second entry is office聽
supplies, so each month the business might have an聽聽
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average of $400 in office supplies. Third one says聽
rent forgone on a self owned building, so this聽聽
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business operator owns the building, and the rent聽
that this business person could have gotten on聽聽
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this building if he or she had not used it for his聽
or her own business is, let's say it's estimated聽聽
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at $1,000 per month. Now there's also the fourth聽
one, interest forgone on self own funds, let's say聽聽
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that the business person has invested $100,000聽
of his or her own money into the business, and聽聽
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perhaps that could have earned this person $700聽
each month in the bank, if this person hadn't used聽聽
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the funds for his or her own business. Now there's聽
also a loan that this business has taken out,聽聽
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and we've got to pay interest to the bank, and聽
perhaps some principle, but let's say the expenses聽聽
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on the loan each month are $500. And then the last聽
expense is monthly equipment leasing expenses. So聽聽
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we have equipment, we have machines, and we have聽
leased them, rented them in a way, and let's say聽聽
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that that costs $800. Now the question is, what聽
are the explicit costs and what are the implicit聽聽
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costs? First of all let's do the explicit costs.聽
So the explicit costs, let's identify them. So聽聽
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these are visible, out-of-pocket expenses. Well,聽
first of all, wages to employees is an explicit聽聽
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cost, so that's 6,000. And then office supplies,聽
another explicit cost, so I'm going to say 400,聽聽
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I'll leave out the dollar sign here. And then聽
rent forgone, that is not really an explicit聽聽
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cost. Interest foregone is also an implicit cost.聽
Interest paid to the bank, that's an explicit聽聽
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cost, comes directly out of the checkbook, out聽
of the checking account, so that's 500. And then聽聽
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let's take a look at the monthly leasing expenses,聽
yes, that's another explicit cost. So another聽聽
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$800, we'll write that over here. And all that聽
adds, if you add it all up, 6,000 plus 400, 6,400,聽聽
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plus 500, 6,900 plus 800 is 7,700, and let's聽
squeeze that in here. 7,700 for total explicit聽聽
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cost. Now let's take a look at the implicit costs,聽
the implicit costs are not out-of-pocket expenses.聽聽
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They are really sacrificed or forgone earnings,聽
if we had not run this business, how much could we聽聽
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have earned? Well, rent forgone is certainly one,聽
so if we hadn't used our own building, we could聽聽
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have earned 1,000 dollars a month, plus, next聽
one, interest forgone is also an implicit cost,聽聽
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so that's 700. And so the total implicit costs聽
listed here add up to 1,700. If you wanted to聽聽
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look at the total economic costs, which is the sum聽
of explicit plus implicit costs, it would add up聽聽
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to 7,700 plus 1,700. By the way, sometimes聽
in problems that we will have on the quiz,聽聽
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another implicit cost would be the value of the聽
owners time, and if that's specifically mentioned聽聽
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then the value of the owners time is also an聽
implicit cost, here it's not listed, so perhaps聽聽
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this owner of this business would be paying聽
himself through a wage, perhaps a salary, so that聽聽
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would be included in this. And it is an explicit聽
cost if it's, if he or she is on the payroll.聽聽
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So that's the sum of the total economic costs,聽
explicit and implicit costs, hope it makes sense.
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