Definition: An imputed cost, also known as a hidden or implicit cost, is the price of production factors that a firm owns and utilizes. It is called “imputed” because the firm does not report it on its financial statements as a separate cost.
What Does Imputed Cost Mean?
What is the definition of imputed cost? Although implicit costs do not require financial expenditure, it is a cost of production. If the factors of production were not used to produce a particular good, they could be used for other productive activities, thereby generating additional income for the firm.
Put simply imputed costs are the opportunity costs that the firm gives up when using its resources. For instance, if a company uses its own buildings for production, it loses the income from renting it or selling to a third party. As this is not a financial expenditure, the firm does not report it on its financial statements.
Let’s look at an example.
Example
Mary is an economist looking for a job. Her cousin, John, tells her that with her skills and knowledge, it would be best to start her own business instead of working for somebody else. Mary thinks that John is right. So, she decides to follow her childhood dream and open a bookstore. She believes that she will be able to run it with a profit since she knows how the market operates, and how the book prices are determined.
Mary invests an initial capital of $50,000 in her venture. If she worked for an esteemed financial institution, she would earn $80,000 per year. What is Mary’s implied cost?
Mary is giving up $80,000 to start her own venture. So, $80,000 is the opportunity cost, i.e. the money that she would earn per year if she hadn’t decided to open a bookstore. As an economist, she will measure the economic profit of the business by including both the explicit and imputed costs. If the total revenues of her business exceed both the explicit and imputed costs, Mary’s venture has an economic profit.
Summary Definition
Define Imputed Cost: Imputed costs are notional costs that a firm foregoes by taking one action or strategy over another.
