Accounting vs. Economic Costs: Examples & Comparison

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  • 0:04 Accounting Costs
  • 0:53 Economic Costs
  • 2:06 An Example
  • 3:28 Using Economic vs…
  • 4:36 Lesson Summary
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Lesson Transcript
Instructor: Dr. Douglas Hawks

Douglas has two master's degrees (MPA & MBA) and a PhD in Higher Education Administration.

It's easy to identify costs associated with running a business - labor, materials, rent, and advertising. These are all accounting costs, and in this lesson, we'll discuss how they compare to economic costs, and why it matters.

Accounting Costs

The costs associated with running a business clearly depend on the type of business that you are running, but generally speaking, we can probably name a few of the costs any business has to deal with at some point in time. There is the cost of labor — someone has to get paid for doing work, after all, and even if it's just you running your business, you obviously need to make money. There's equipment or materials— since you are selling something, you either need materials to make your product or equipment to create the content you sell.

All of these costs are called accounting costs. Accounting costs are those costs that have a specific monetary value you need to pay in order to receive the associated benefit. Accounting costs are also called explicit costs. Explicit costs are those stated costs that occur in exchange for a defined good or service.

Economic Costs

Economic costs include accounting costs, but they also include opportunity costs. Opportunity costs are the benefits you could have received if you had chosen one course of action, but that you didn't because you went with another option. An example is probably helpful here. Imagine that you own a building and you use it as a warehouse for materials and finished products. If you weren't using that building, you could lease it for $3,000 per month. By using it as storage, you are missing out on the $3,000 in opportunity costs.

You are probably thinking, 'Okay, but if I did that, where would I store my materials and products?' Great question, and this really highlights why it is really important to know the opportunity costs of your decisions. If you leased another building, say for $4,000 a month, then the opportunity cost of $3,000 is well worth the tradeoff; or, if you could limit the amount of material and product you needed to store and find a place to lease for $1,000 per month, you may want to consider doing that. Then you'd actually be making a $2,000 accounting profit.

Opportunity costs are also called implicit costs, since these are the costs of doing business, but not ones that ends up coming out of your bank account or on financial statements; they're just implicit in the simple act of doing business.

An Example

Let's look at another quick example of a decision to identify the difference between accounting costs, economic costs, and why we should pay attention to both. We'll keep it simple, and not even in the business context. It'll be in the context of a decision that most people in the United States should be making, or at least considering: attending college.

The case for attending college is far more than financial, but since we are talking about accounting and economic costs, let's focus on the accounting costs. A good estimate for a 4-year college degree in business is about $80,000. That includes books, cost-of-living, etc. So, from an accounting cost perspective, you'll spend $80,000. Those are your explicit costs, or your accounting costs.

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