Cost and Payment

A common perception, especially among those not trained in the subtleties of economics, is that the terms "cost" and "payment" are synonymous. In other words, a cost is incurred only when money trades hands. And whenever money trades hands, a cost occurs.

Cost, however, is synonymous with foregone satisfaction, and may or may not involve a money payment. When an opportunity cost does NOT involve a money payment, it is an implicit cost.

Consider an example.

• The Activity: Suppose that Edgar Millbottom, a typical fun-loving Shady Valley teenager, is working part-time at Waldo's TexMex Taco World in the Shady Valley Sprawling Hills Shopping Mall. Edgar spends four hours each afternoon making tacos and running the cash register.


• The Opportunity Cost: The four hours Edgar spends at the Waldo's TexMex Taco World is time that cannot be spent pursuing other activities. Edgar's best, most satisfying alternative, is playing video games with his friends at Alicia Hyfield's house. The opportunity cost of working at Waldo's TexMex Taco World is this foregone satisfaction.


• No Payment: Unfortunately, Edgar receives no payment for his effort. Waldo's TexMex Taco World is owned by his father, Waldo Millbottom. Edgar stops by the restaurant each afternoon to lend a hand, to help out the family, to be a good son. But he is not a paid employee. He is not compensated for his foregone satisfaction. As such, Edgar's foregone satisfaction is an implicit cost.

No Compensation

While it might seem as though almost every opportunity cost involves a payment of some sort, the existence of implicit cost is quite prevalent in the economy. Consider two examples:

• Normal Profit: The standard textbook example of implicit cost is normal profit, the opportunity cost of entrepreneurship. Normal profit is the profit that entrepreneurship foregoes from one production activity by engaging in another production activity. For example, Manny Mustard uses his entrepreneurial skills in the production of sandwiches by operating Manny Mustard's House of Sandwich. He foregoes profit that could be earned in an alternative business venture, such as Manny Mustard's Pet Store. As the proprietor of this establishment, he does not pay himself an explicit profit. The unpaid profit that Manny forgoes and is an implicit cost.


• Externalities: A second noted example of implicit cost comes under the heading of externalities, which includes any cost or benefit external to market transactions. An external cost, in particular, is inevitably an implicit cost. Because an external cost is external to the market, there is no explicit payment. For example, the Mona Mallard Duct Tape factory tends to spew noxious chemicals into the air when producing duct tape. These chemicals make it difficult for nearby residents to breath, hence imposing an opportunity cost on these folks. Mona Mallard does not compensate these neighbors for their foregone satisfaction, making this external cost an implicit cost.

An Explicit Alternative