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CMA Foundation · Fundamentals of Business Economics and Management · Utility, Wealth, Production

A firm's manager says: 'We should use the next best alternative use of our own owned warehouse, which could be rented out for ₹4,00,000 a year, as part of the cost of running our own business there.' Under the economic approach, the ₹4,00,000 is best called:

The ₹4,00,000 is an opportunity cost, which forms part of economic cost. It is the income forgone by not renting out the warehouse, an implicit cost with no cash outflow. Business economics includes such costs when judging decisions, so economic profit is lower than accounting profit.

  1. AAn explicit cost that appears in the books as cash paid
  2. BA sunk cost that must be ignored in every case
  3. CAn opportunity cost forming part of economic costCorrect
  4. DA fixed asset depreciation charge

Explanation

The forgone rent from the best alternative use is an opportunity cost. It is an implicit cost, since no cash is paid out. Economic cost includes both explicit and implicit costs, so economic profit is lower than accounting profit by the implicit costs. It is not a sunk cost because the choice to use the warehouse is still open.

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