Economic Cost: Definition & Function

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  • 0:00 What Is Economic Cost?
  • 0:51 Examples Of Economic Cost
  • 2:35 Why Calculate Economic Cost?
  • 3:15 Lesson Summary
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Lesson Transcript
Instructor: Shawn Grimsley
Economic decisions are about measuring costs against benefits. In this lesson, you'll learn about economic cost and its function in economic decision-making. You'll also have a chance to take a short quiz after the lesson to reinforce your knowledge.

What Is Economic Cost?

Also known as opportunity cost, economic cost is the value you give up when you choose one economic activity over the next best economic activity. Such economic activities might include buying goods or services or staring a business. You can calculate the economic cost by finding the difference between the chosen economic activity and the alternative economic activity. The classic example of economic cost looks at guns and butter, examining defense spending versus social spending. In order to produce a certain amount of guns, you have to give up producing a certain amount of butter, and the difference in value is the economic cost for producing the guns. Keep in mind that economic costs are different than accounting costs; accounting costs refers strictly to monetary value, while economic cost includes monetary value as well as other values, like resources and satisfaction.

Examples of Economic Cost

Let's look at some more examples of economic cost. Say that you have to decide whether to take a recently offered job or start your own business. Given your current client base, you believe that you can reasonably project net income of $75,000 for the first year of operating your own business. The job offer has a compensation package valued at $100,000 for the first year. If you decide to start your business, the monetary component of your economic cost is $25,000. This amount is the difference between the value of running your own business ($75,000) and the value of the alternative you are giving up ($100,000). Considering only monetary value, taking the job offer would be the wisest business decision; however, if you value the independence, challenge, and freedom of owning your business as being worth at least $25,000, then the better economic decision may be to decline the job offer and open up shop.

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