COSTS AS OPPORTUNITY COSTS

When measuring costs at Hungry Helen’s Cookie Factory or any other firm, it is important to keep in mind one of the Ten Principles of Economics from Chapter 1: The cost of something is what you give up to get it. Recall that the opportunity cost of an item refers to all those things that must be forgone to acquire that item. When economists speak of a firm’s cost of production, they include all the opportunity costs of making its output of goods and services.

A firm’s opportunity costs of production are sometimes obvious but sometimes less so. When Helen pays $1,000 for flour, that $1,000 is an opportunity cost because Helen can no longer use that $1,000 to buy something else. Similarly, when Helen hires workers to make the cookies, the wages she pays are part of the firm’s costs. Because these costs require the firm to payout, some money, they are called explicit costs. By contrast, some of a firm’s opportunity costs, called implicit costs, do not require a cash outlay. Imagine that Helen is skilled with computers and could earn $100 per hour- working as a programmer. For every hour that Helen works at her cookie factory, she gives up $100 in income, and this forgone income is also part of her costs. The total cost of Helen’s business is the sum of the explicit costs and the implicit costs.

The difference between economists and accountants is easy to see in the case of Hungry Helen’s Cookie Factory. When Helen gives up the opportunity to earn money as a computer programmer, her accountant will not count this as a cost of her cookie business. Because no money flows out of the business to pay for this cost, it never shows up on the accountant’s financial statements. An economist, however, will count the forgone income as a cost because it will affect the decisions that Helen makes in her cookie business. For example, if Helen’s wage as a computer programmer rises from $100 to $500 per hour, she might decide that running her cookie business is too costly and choose to shut down the factory to become a full-time computer programmer.

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