Microeconomics For Dummies
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Economists look at costs in a particular way, which may not be what you expect. Every firm in every industry in every country incurs costs of one kind or another, and accounting systems provide a way of measuring and recording them.

But economists are interested in more than the record of what was done in the past. They also want to know what opportunities the firm did not pursue or what the firm could have done had it not made the decision it did. Therefore, economists tend to look at costs in a different way.

In a set of company accounts, you find many items that describe costs, from costs of goods sold to overheads to general expenditures (these are accounting costs). Company accounts are produced to a set of standards that reflect the accounting profession's view of how best to describe the costs of a company, given that those costs are incurred in different ways and at different stages of production. As a result, companies report many different cost measures, and accountants know how to interpret these measures as needed.

Economists treat costs in a slightly different way, called, unsurprisingly, economic costs. Whereas an accountant needs to know what costs have accrued over the past year, an economist wants to examine costs as they relate to the firm's decision-making. This involves some key subtleties, the most important of which is that economic costs account for the opportunities the firm had to give up in order to do what it's doing.

Economists call these opportunity costs. In principle, a firm has to account for them before going on to make any decisions about production or investment so that it knows it's making the decision on a rational basis.

If you're scratching your head a little, here's an example to relieve that itch.

Suppose you gave up a decently paying job to start a business and at the end of your financial year your accountant sends you a statement saying that your revenue was in excess of your costs by $25,000. You're happy with this, considering that an accounting profit of $25,000 is a decent return on your business. But then your economist friend points out that the job you gave up was paying a net salary of $35,000, which means that you gave up an opportunity to make $10,000 more than you received from your new business.

In fact, your accounting profit of $25,000 was an economic loss of $10,000 when you factor in the opportunity cost of giving up your old job to start your business. (Economics is called the dismal science for a reason.)

The upshot is that when looking at the individual types of cost a firm incurs, you can assume that economists are talking about economic costs that include opportunity costs.

About This Article

This article is from the book:

About the book authors:

Lynne Pepall, PhD, is a professor of economics at Tufts University. She has taught microeconomics at both graduate and undergraduate levels since 1987.

Peter Antonioni is a senior teaching fellow at the Department of Management Science and Innovation, University College, London, and coauthor of Economics For Dummies, 2nd UK Edition.

Manzur Rashid, PhD, is a lecturer at New College of the Humanities, where he covers second-year micro- and macroeconomics.

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