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Fundamentals of Business Economics and Management · Cost of Production

Concept and Types of Cost in Economics

Updated 10 October 2026 · Fact-checked

Cost of production is the total expense a firm bears to produce goods or services. Types of cost are explicit (paid out), implicit (owner's own resources), opportunity (next best alternative given up), private (borne by the firm) and social (borne by society). Classify each item by who pays and whether money moves.

Understand Concept and Types of Cost

Cost of production is what a firm spends or sacrifices to make a product. It covers the price of raw materials, wages, rent, interest and the reward for the entrepreneur. Economists look at cost more widely than a bookkeeper does.

Start with opportunity cost. Resources are scarce, so using them for one purpose means giving up another. The opportunity cost of a choice is the value of the next best alternative you gave up. If you spend a Sunday studying instead of earning ₹500 at a part-time job, your opportunity cost is ₹500.

Costs are split into explicit and implicit. Explicit costs are actual cash payments to outsiders, such as wages, rent paid to a landlord, and raw material bills. Implicit costs are the value of the owner's own resources used in the business, such as the rent the owner could have earned on their own shop, or their own salary foregone. No cash is paid, but the cost is real.

Accounting cost includes only explicit costs. Economic cost includes explicit plus implicit costs. So economic cost is always at least as large as accounting cost, and accounting profit is at least as large as economic profit.

Private cost is the cost the producer bears directly. Social cost is the total cost to society: private cost plus the external cost imposed on others, such as pollution from a factory. When a firm does not pay for the harm it causes, social cost exceeds private cost.

Key formulas to remember

Economic cost
Economic cost = Explicit cost + Implicit cost
Accounting cost equals explicit cost only.
Opportunity cost
Opportunity cost = Value of the next best alternative foregone
It is the single best alternative given up, not the sum of all alternatives.
Social cost
Social cost = Private cost + External cost
External cost falls on third parties, such as pollution or congestion.
Economic profit
Economic profit = Total revenue − (Explicit cost + Implicit cost)
Accounting profit = Total revenue − Explicit cost.

How to solve Concept and Types of Cost questions

Most questions ask you to identify a cost type or compute one. Use this method.

  1. 1Read the question and note the exact term asked: explicit, implicit, opportunity, private, social, accounting or economic.
  2. 2Ask whether money is actually paid to an outsider. If yes, it is explicit. If it is the owner's own resource, it is implicit.
  3. 3For opportunity cost, list the alternatives and pick only the next best one.
  4. 4For private versus social, ask who bears the cost. The firm alone means private. If others suffer without payment, add that external cost to get social cost.
  5. 5For numerical questions, add explicit and implicit costs to get economic cost, then subtract from revenue for economic profit.
  6. 6Check the answer against the rule: economic cost is not less than accounting cost, and social cost is not less than private cost when external costs are harmful.

Quickest way: Pay-or-sacrifice test

When to use it: Use for one-line classification MCQs where you must name the cost type quickly.

  1. Cash paid to an outsider? Choose explicit or accounting cost.
  2. Owner's own land, money or time, no cash paid? Choose implicit cost.
  3. Phrase says 'next best alternative' or 'foregone'? Choose opportunity cost.
  4. Phrase says 'borne by society' or 'pollution'? Choose social cost.
  5. In a sum, add explicit and implicit and eliminate options that equal explicit alone.

Common mistakes in Concept and Types of Cost

  • Treating implicit cost as a cash payment.

    Students link every cost with a bill or payment.

    Fix: Remember implicit cost involves no outflow. It is the owner's own resource valued at what it could earn elsewhere.

  • Adding all alternatives to find opportunity cost.

    The word 'cost' suggests summing.

    Fix: Opportunity cost is only the value of the best alternative given up.

  • Saying accounting cost includes implicit cost.

    Confusion between accounting and economic cost.

    Fix: Accounting cost is explicit only. Economic cost adds implicit cost.

  • Confusing private cost with social cost.

    Both words sound like general expense.

    Fix: Private cost is what the firm pays. Social cost adds the external harm to others.

  • Subtracting implicit cost when computing economic cost.

    Students mix cost with profit calculation.

    Fix: Add implicit cost to explicit cost for economic cost. Subtract the total from revenue for profit.

Worked examples

Example 1

Ravi runs his own shop in his own building. In a year, revenue is ₹12,00,000. He pays ₹7,00,000 in wages, materials and electricity. The building could be rented out for ₹2,00,000 a year, and he gave up a job paying ₹3,00,000. Find the accounting profit and economic profit.

Show the solution
  1. Explicit cost = ₹7,00,000.
  2. Accounting profit = ₹12,00,000 − ₹7,00,000 = ₹5,00,000.
  3. Implicit cost = ₹2,00,000 + ₹3,00,000 = ₹5,00,000.
  4. Economic cost = ₹7,00,000 + ₹5,00,000 = ₹12,00,000.
  5. Economic profit = ₹12,00,000 − ₹12,00,000 = ₹0.

Answer: Accounting profit is ₹5,00,000 and economic profit is ₹0.

Example 2

A chemical factory spends ₹40 lakh a year on production. Its waste harms nearby farmers, causing a loss of ₹6 lakh a year. What is the private cost and the social cost?

Show the solution
  1. Private cost is what the firm bears: ₹40 lakh.
  2. External cost is the loss to farmers: ₹6 lakh.
  3. Social cost = Private cost + External cost = ₹40 lakh + ₹6 lakh = ₹46 lakh.

Answer: Private cost is ₹40 lakh and social cost is ₹46 lakh.

Exam tips

  • Most questions are definition or classification MCQs. Learn the one-line difference for each pair.
  • In numerical MCQs, check whether the question asks for accounting or economic profit before calculating.
  • Watch for options that give explicit cost alone when economic cost is asked.
  • Words like 'foregone', 'next best' and 'sacrificed' point to opportunity cost.
  • Pollution, congestion and noise examples point to social cost.

Practice questions from Cost of Production

Concept and Types of Cost in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Concept and Types of Cost: frequently asked questions

What is the difference between explicit and implicit cost?

Explicit cost is an actual cash payment to outsiders for inputs, like wages or rent paid. Implicit cost is the value of the owner's own resources used in production, with no cash paid. Both together form economic cost.

What is opportunity cost with an example?

Opportunity cost is the value of the next best alternative given up when you make a choice. If a farmer uses land for wheat instead of rice that would have earned ₹50,000, the opportunity cost is ₹50,000.

What is the difference between private cost and social cost?

Private cost is the cost the producer pays directly. Social cost is private cost plus the external cost borne by society, such as pollution damage. Social cost exceeds private cost when the firm causes uncompensated harm.

Why is economic profit usually lower than accounting profit?

Economic profit also deducts implicit costs, such as the owner's foregone salary and rent. Accounting profit deducts only explicit costs. So economic profit is lower whenever implicit costs are positive.