Explicit costs
a. include income that is forgone by the firm’s owners.
b. include all of the firm’s opportunity costs.
c. require an outlay of money by the firm
d. All of the above are correct.
The correct answer and explanation is :
Correct Answer:
c. Require an outlay of money by the firm.
Explanation:
Explicit costs are the direct, out-of-pocket expenses that a firm incurs while conducting its business operations. These costs require a tangible outflow of money and are recorded in the company’s financial statements. Examples of explicit costs include wages paid to employees, rent for office space, cost of raw materials, utility bills, and advertising expenses.
Why Option C is Correct?
- Explicit costs involve a financial transaction. They are monetary payments made to outside parties such as suppliers, workers, landlords, or service providers.
- They appear in accounting records. Since explicit costs involve actual money payments, they are documented in the firm’s income statement and are used to calculate accounting profit.
- They differ from implicit costs. Implicit costs, unlike explicit costs, are the opportunity costs of using resources owned by the firm. For example, if a business owner forgoes a salary to run their own business, that lost salary is an implicit cost.
Why the Other Options are Incorrect?
- Option A is incorrect because forgone income (like a business owner not taking a salary) is an implicit cost, not an explicit cost.
- Option B is incorrect because explicit costs do not include all opportunity costs. Opportunity costs also include implicit costs, which do not require an actual outlay of money.
- Option D is incorrect because both A and B contain incorrect statements.
Conclusion:
Explicit costs are essential in business decision-making as they determine the firm’s actual cash expenses. They are crucial for calculating accounting profit, but they do not fully capture the total economic cost, which also includes implicit costs.