Economic vs. Accounting costs

An essential characteristic of the cost curves we have observed is that they are based on real production relationships. The dollar costs we compute are a direct reflection of underlying resource costs — the land, labor, and capital used in the production process. Not everyone counts this way. On the contrary, accountants and businesspeople typically count dollar costs only and ignore any resource use that doesn't result in an explicit dollar cost.

Return to Tight Jeans for a moment to see the difference. When we computed the dollar cost of producing 15 pairs of jeans per day, we noted the following resource inputs:

Inputs cost

1 factory rent @ $ 10

1 machine rent @ 20

1 machine operator @ 80

1.5 bolts of denim @_ 45

Total cost $245

The total value of the resources used in the production of 15 pairs of jeans was thus $245 per day. But this figure need not conform to actual dollar costs. Suppose the owners of Tight Jeans decided to sew jeans. Then they would not have to hire a worker or pay $80 per day in wages. Dollar costs would drop to $165 per day. The producers and their accountant would consider this to be a remarkable achievement. They would assert that the costs of producing jeans had fallen.

Economic cost An economist would draw no such conclusions. The essential economic question is how many resources are used in production. This has not changed. One unit of labor is still being employed at the factory; now it's simply the owners, not a hired worker. In either case, one unit of labor is not available for the production of other goods and services. Hence society is still paying $245 for jeans, whether the owners of Tight Jeans write checks in that amount or not. We really don't care who sews jeans — the essential point is that someone (i.e., a unit of labor) does.

The same would be true if Tight Jeans owned its own factory rather than rented it. If the factory was owned rather than rented, the owners probably would not write any rent checks. Hence accounting costs would drop by $100 per day. But society would not be saving any resources. The factory would still be in use for jeans production and therefore unavailable for the production of other goods and services. The economic (resource) cost of producing 15 pairs of jeans would still be $245.

The distinction between an economic cost and an accounting cost is essentially one between resource and dollar costs. Dollar cost refers to the actual dollar outlays made by a producer; it is the lifeblood of accountants. Economic cost, in contrast, refers to the dollar value of all resources used in the production process; it is the lifeblood of economists. The accountant's dollar costs are usually explicit, in the sense that someone writes a check. The economist takes into consideration implicit costs as well, that is, even those costs for which no direct payment is made. In other words, economists count costs as

• Economic cost =^: explicit costs + implicit costs

As this formula suggests, economic and accounting costs will diverge whenever any factor of production is not paid an explicit wage (or rent, etc.).

The Cost of Homework. These distinctions between economic and accounting costs apply also to the "production" of homework. You can pay people to write term papers for you, and at large schools you can often buy lecture notes. But most students end up doing their own homework, so that they will learn something and not just turn in required assignments.

Doing homework is expensive, however, even if you don't pay someone to do it. The time you spend reading this chapter is valuable. You could be doing something else if you weren't reading right now. What would you be doing? The forgone activity – the best alternative use of your time – represents the economic cost of doing homework. Even if you don't pay yourself for reading this chapter, you'll still incur that economic cost.

1. Formulate the main idea of the text.

2. Find in the text English equivalents of these words and phrases.

.важлива характеристика	13. оренда фабрики	25. доларові планові капітальні витрати
крива витрат	14. загальна вартість ресурсів	26.невід’ємний елемент бухгалтерії
спостерігати, помічати	15. погоджуватися з загальною вартістю у доларовому еквіваленті	27. порівняно з
виробничі взаємовідношення	16. наймати робітника	28. явні витрати, зовнішні витрати
відображення	17. видатне досягнення	29. внутрішні витрати, наявні витрати
навпаки	18.заявляти, відстоювати права	30. іншими словами
брати до уваги, враховувати	19. в іншому випадку	31.відхилятися, розходитися
витрати у доларовому еквіваленті	20. наявний, придатний	32.необхідні асигнування
ігнорувати	21. отже	33.попередня діяльність
закінчуватися (чим)	22. виписати чек	34.представляти, являти (собою)
за день	23. рахунок витрат
помічати, звертати увагу	24. економічні витрати

3. Are these statements true or false? Correct the false ones.

1. The economic costs of production include the value of all resources used.

2. Accounting costs typically include only those dollar costs actually paid (explicit costs).

3. The cost curves are based on real production relationships.

4. Accounts and businessmen count both dollar costs and resource use.

5. How many resources are used in production is the main economic question.

6. The difference between an economic cost and an accounting cost is the difference between resource and dollar costs.

7. An accounting cost refers to dollar value of all resources used in the production process.

8. The economist does not take into consideration implicit costs.

4. Write a summary of the text.

Text 19