Imputed cost

Updated: Aug 20, 2021

The opportunity cost of inputs owned by a firm, which it ‘supplies’ to itself and which have alternative uses. The owner of a firm may supply certain factors of production – the use of a site he owns, finance for investment, managerial services, etc. In practice, he may not be paid the ‘price‘ of each of these inputs, but rather will take the residual of revenues after all payments have been made to factors of production ‘bought in’. However, any input supplied by the owner may have an alternative use, with a corresponding price, and this represents the effective cost of using that input in the firm in question. Hence, we could attribute a price to each input supplied by the owner of the firm, even if no explicit price is in fact paid. Such a price is called the ‘imputed cost’ of the input. For example, if the firm owns the land it uses and pays no explicit rent, we can impute a rent for that land, equal to what the firm could obtain for it in some alternative use. A similar interpretation could be given to imputed interest (finance supplied by the owner) and imputed salary (managerial services supplied by the owner). The important corollary to the doctrine of imputed costs is the idea that if sales revenues are insufficient to cover actual outlays and imputed costs, then, in the long-run, the firm should not stay in business. If it does stay in business, it must mean that the factors owned by the firm are receiving less than their imputed costs, and hence could be more profitably employed elsewhere. On the other hand, if the revenues remaining after payment of all actual outlays exceeds the imputed costs, then the firm is earning excess or super-normal profit.

Reference: The Penguin Dictionary of Economics, 3rd edt.

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James Knight
Editor of Education
James is the Editor of Education for Invezz, where he covers topics from across the financial world, from the stock market, to cryptocurrency, to macroeconomic markets.... read more.