Instead of buying something, we could have spent the same amount of money on something else. This is the essence of opportunity cost. There are two kinds of opportunity cost:
- explicit costs
- implicit costs
Explicit costs are those that are paid in money.
Implicit costs are not paid in money. They occur when a company uses an asset instead of renting, selling, or lending it. Examples of implicit costs include
- Economic depreciation
- Forgone interest
- Normal profit
Economic depreciation is the changing market value of capital measured over a given period. Normal profit is the return that an entrepreneur could earn on average.
Susan runs a business. She could earn $30,000 a year if she was employed at Todo Ltd.
Therefore, her normal profit is $30,000. If she wants to compute the cost of her own business, she has to keep in mind this amount – the normal profit – as part of the implicit costs.