Question

How do you differentiate between opportunity cost and explicit cost? Why the discussion of opportunity cost is rellevant?

Answer 1

An explicit cost is cost for which actual payment is made and can be recorded in the books. Thus payments for wages and rental will be explicit costs. Opportunity cost on the other hand cannot be tangible and so no official payment for it is made and nothing is recorded in the books. It is the cost of the next best alternative forgone for an action.Discussion of opportunity cost is important as it gives an idea of what is being forgone in choosing an action. Say we can invest in one of two projects and we choose project A and not project B, the opportunity cost of not choosing project B must be included in any cost benefit analysis. Thus explicit costs can be given a tangible value and shown in the books and opportunity cost cannot but both are important.