Angus works as a dairy farmer and loves his work. Because the dairy business hasn\’t been doing well lately, Angus is considering changing careers. He could work as a technician at the local dairy plant, and earn $27,000 a year. Angus decides to make a list of the costs of staying in business as a famer and asks you for help. Please sort Angus\’ costs below according to whether they are explicit costs or implicit costs.
The correct answer and explanation is:
Correct Sorting of Costs:
Explicit Costs:
- Feed for the cows
- Veterinary bills
- Electricity for the milking machines
- Repairs for farm equipment
- Fertilizers for the fields
Implicit Costs:
- Angus’s time working on the farm
- The opportunity to earn $27,000 a year as a technician
- The potential rental income from the farmland if leased to another farmer
Explanation:
When evaluating Angus’s situation, it’s essential to differentiate between explicit costs and implicit costs, as they both contribute to understanding the true economic costs of staying in the dairy farming business.
Explicit Costs:
Explicit costs are the direct, out-of-pocket expenses required to run the farm. These costs involve monetary payments for goods and services essential for maintaining operations. Examples include feed for the cows, veterinary bills, electricity for the milking machines, repairs for farm equipment, and fertilizers for the fields. These costs are recorded in accounting books because they directly impact cash flow and are necessary for production.
Implicit Costs:
Implicit costs, on the other hand, represent the opportunity costs of using resources that Angus owns instead of employing them elsewhere. For instance, the time Angus spends working on the farm could be used to earn a salary as a technician, valued at $27,000 annually. This forgone salary is an implicit cost of continuing to farm. Similarly, Angus could lease his farmland to another farmer, earning potential rental income, which is another implicit cost. These costs are not directly recorded in accounting records but are crucial in calculating economic profit, which considers both explicit and implicit costs.
Conclusion:
By analyzing both explicit and implicit costs, Angus can make an informed decision. If the total economic costs (explicit + implicit) of farming exceed the benefits or profits, switching careers or leasing his land might be a better financial choice. Factoring in implicit costs ensures Angus evaluates his options holistically.