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Economic Theory

Implicit costs of production, on the other hand, are the costs of self-
owned and self-employed resources. These costs are normally ignored
while calculating the expenses of a producer. These include the rewards
for the entrepreneur’s self-owned land, labor and capital. These costs do

not appear in the accounting records of the firm.
The sum of explicit costs and implicit costs constitutes the total cost of

production of a commodity.
Opportunity / Alternative / Transfer Cost. The concept of opportunity
cost is the most important concept in economic theory. In the simplest
terms, opportunity cost of a decision may be defined as the cost of next

best alternative sacrificed in order to take this decision. In short, the
opportunity cost of using resources to produce a good is the value of the
best alternative or opportunity forgone. Opportunity costs include both

explicit and implicit costs. For example, if with a sum of Rs. 2000, a
producer can produce a bicycle or a radio set and decides to produce a
radio set. In this case, opportunity cost of a radio set is equal to the cost of
a bicycle that he has sacrificed.

Private, External and Social Costs. A cost that is not borne by the
firm, but is incurred by others in society is called an external cost. The true
cost to the society must include all costs regardless of who bears them.

Private costs refer to the costs to a firm in producing a commodity. It is, in
fact, the money costs of the firm. For example, the purchase price of a car
reflects the private cost experienced by the manufacturer. The air pollution
created in the production of the car however, is an external cost. Because

the manufacturer does not pay for these costs, and does not include them in
the price of the car, they are said to be external to the market pricing

mechanism. The air pollution from driving the car is also an externality.
The driver does not pay for the environmental damage caused by using the
car.
Social cost is the total of all the costs associated with an economic

activity. It includes both costs borne by the economic agent and also all
costs borne by society at large. It includes the costs reflected in the
organization’s production function (called private costs) and the costs

external to the firm’s private costs (called external costs). Thus, it is the
cost of producing a commodity to the society as a whole. Hence, the social
cost is the sum of private and external cost.
That is,

Social Cost = Private Cost + External Cost (8.1)

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