The costs involved in the production can be classified into two: explicit and implicit costs.
1. Explicit Costs:
These are payments made by the firm when it purchases or hires factors of production in a production process. They include rent on land or business space, wages and salaries to labour and interest on loaned funds.
2. Implicit Costs:
These are costs that do not require out-of-pocket expenses by the firm. Implicit costs are the imputed money value of the owner’s resources that are used in the production process. The salary forgone by an entrepreneur for his labour services, the rent forgone for using his house for business, and the hiring fee forgone by using his car to do running around for the business, are all examples of implicit costs.
To the economists, the sum of both the explicit and the implicit costs constitute the total cost of production. To the accountants, who are interested in the outflow and inflow of money, the explicit costs only constitute the total cost of production.
Economic Cost = Explicit Costs + Implicit Costs
Accounting Cost = Explicit Costs