Imputed costs are what?

Any process and life itself is a series of elections. Deciding to invest the money earned in the purchase of new equipment, the entrepreneur refuses an infinite number of possibilities for their use. Here and there are imputed costs. This is the projected profit from deciding in favor of the best alternative after the planned course of action. They characterize the benefits, which had to be abandoned, making the final choice. An imputed concept is a concept that is best suited to consider two mutually exclusive events. For example, the choice between buying for the profit earned in the current period of new equipment or increasing the work of employees of the enterprise.

Study history

The term "imputed costs" is a product of the work of the Austrian economist Friedrich von Wieser. He first used it in his book Theory of Social Economy, published in 1914. However, the idea has long been in the academic community. Benjamin Franklin formulated the famous saying: "Time is money". His concept he described in the book "Advice to young merchants" back in 1764. Franklin gives an example with a man who earns ten shillings a day. Consider his rest. Let him spend sixpence and half a day on entertainment. At first glance, his expenses are obvious. It's sixpence. However, there are also alternative imputed costs - the five shillings that he could earn in half a day. Hence the famous saying of Franklin that time is always money. Obviously, the idea of imputed costs in the essay "About what is visible, and about what is not visible" by Frederick Bastia, written in 1848, is obvious. In it the author cites an example of a metaphor for a broken fire. It dispels the widespread belief that catastrophes, wars, terrorism, and other misfortunes can contribute to economic growth. The essence of the metaphor is that the boy knocked out a window in the bakery and ran away. Its replacement costs 3000 conventional units. Some people believe that this event is not negative. The glazier will receive an additional 3000 conventional units, then spend it, and this will lead to a revival of the local economy. However, in such reasoning, according to Bastia, there is a mistake. It is that the baker needs to spend money to restore the window from his own pocket. And this amount will be lost to other producers in the region. After all, they could become potential buyers of a baker. Therefore, the economy was not enriched, but lost 3000 conventional units. Representatives of the Keynesian direction believe that the boy can benefit the economy, but only during crises, when resources are underutilized. Austrian economists, like Bastia in his time, interpret the metaphor in a different way. Suppose the boy actually paid the glazier. Then immediately it becomes clear that in fact there is a theft of 3000 conventional units. The economy is not enriched, only the glazier gets benefits, and at the expense of others.

Evaluation

When an entrepreneur decides on the investment of earned money, he looks for the option with the highest return. Often calculated the expected rate of return on investment and the payback period. However, any final decision is always associated with the emergence of alternative costs. For example, an entrepreneur makes a choice between buying new equipment and investing in securities. Whichever decision is taken, it is connected with imputed costs. This is the difference between the expected profitability of the chosen option and the one that had to be abandoned.

Imputed costs also play an important role in determining the structure of capital. The decision to expand is always connected with other possibilities. And the accuracy of the choice depends on the accuracy of the forecast of their real profitability. Another important characteristic is risk. It also needs to be considered when making a decision. The existence of risks is the reason that the company does not always choose the most commercially viable option.

In everyday life

Economic imputed costs are a concept that is rarely used by ordinary people. However, in fact, its use in making important decisions related to money embezzlement would be useful. For example, consider buying a new large house. The majority in making this decision will simply consider the pros and cons of such an acquisition, assess the balance on their bank account. But so we miss the imputed costs. After all, it is quite possible that we do not need a big house, and this money can be spent on travel or education, which will bring new knowledge and impressions that will bring income in the future. Or consider another example. Let's say we buy a cheeseburger every day for $ 4.5. If this trend continues for 25 years, it will not only lead to a deterioration in our health. In this case, the imputed costs are 52,000 dollars. And this, if only lay the rate of profitability from investing in 5%.

Explicit costs

There are two types of alternative costs. Explicit ones are connected with direct monetary costs of producers. For example, the company's electricity costs amounted to $ 100 per month . This money could be spent, for example, on the purchase of a printer. Explicit imputed costs are equal to $ 100.

Implied costs

Unlike the costs of the first group, they do not appear clearly in the balance sheet of the firm. They are associated with a risk of failure. For example, the manufacturer purchased 1,000 tons of steel and machinery in order to start the production of certain equipment. Implied imputed costs in this case will be equal to the income lost due to the fact that he did not resell the purchased, did not lease out his capacities.

Choice from set

It should be noted that imputed costs are by no means the sum of possible revenues for all alternative options. This is the rate of profitability for only one of them. To that which is the second on expected profitableness. If someone decides not to work, as in the example of Franklin, then this option is also associated with alternative costs. If we decide to go to the cinema instead of sitting in the office, then the expenses increase. They will be equal to the amount that would be earned per day, plus the cost of tickets.

The law of imputed costs

The production opportunity curve demonstrates the process of choosing from two alternatives. If you look at it, it immediately becomes clear that the imputed costs increase with an increase in the output of one product and a reduction in the other. It turns out that in time, you have to sacrifice more and more of the second good. This is exactly what the law of increasing imputed costs says. Its functioning is due to the fact that not all resources are universal and interchangeable. Let's say we grow corn and wheat, but we decided to gradually begin reorientation in favor of the former. However, not all lands are equally suitable for planting both crops. And over time, we will begin to use the area less efficiently.

Irreversible loss

Now that we understand that the imputed costs are the difference between the expected rate of profitability of the chosen option and the second best alternative, we can consider other concepts. The closest in terms of the concept to them are irrevocable losses. The difference is that she is already considering the money spent. When we think about imputed costs, the amount is still in our pocket. You can change the decision at any time, and invest in another option. But the irrevocable losses arise when we have already invested our profits. Their calculation is connected with the lack of choice.

Example

In our task, the entrepreneur has two options. The first is to invest in the securities market. The second is to invest in the purchase of new equipment, expecting that it will increase the productivity of output. This will lead to a reduction in operating costs and an increase in the rate of return. Suppose that the yield on securities is 12%. And the purchase of equipment will bring only 10% per annum from the invested amount. Of course, the company will choose option one - investing in securities. And the imputed costs are in this example 2% of the invested amount.