purchase of goods or services by the firm. The obvious explicit costs
include the hiring of workers, the rental of equipment, interest payments
on debt, and the purchase of intermediate inputs.
Like accountants, economists subtract from revenues all explicit costs, but
they also subtract some implicit costs that accountants ignore. These are
items for which there is no market transaction but for which there is still
an opportunity cost for the firm that should be included in the complete
measure of costs. The two most important implicit costs are the
opportunity cost of the owner’s time and the opportunity cost of the
owner’s capital. When this more complete set of costs is subtracted from
the firm’s revenues, the result is called economic profit and is
sometimes called pure profit.
Opportunity Cost of Time
Especially in small and relatively new firms, owners spend a tremendous
amount of their time developing the business. Often they pay themselves
far less than they could earn if they were instead to offer their labour
services to other firms. For example, an entrepreneur who opens a
restaurant may pay herself only $1000 per month while she is building
her business, even though she could earn $4000 per month in her next
best alternative job. In this case, there is an implicit cost to her firm of
2Accountingprofits=Revenues−ExplicitcostsEconomic profits = Revenues−(Explicit costs+Implicit costs
= Accounting profits−Implicit costs