Implicit cost arises in the case of those factors, which are possessed and supplied by the entrepreneur himself. There is no contractual obligation for payment to anyone else in order to obtain these factor units. But, the factor units are responsible for costs, since they could be supplied to other producers for contractual sum, if they were not used in this business.
Further, if the same factors were to be hired or purchased by a firm instead of being arranged from its own sources, then, it would certainly have to make payment explicitly to the suppliers of these services. The monetary payment involved would be equal to the amount of money the firm is deprived of, when it avails the services of its own factors of production.
Leftwich defines implicit cost of production as “cost of self-owned, self employed resources that are frequently overlooked in computing the expenses of a firm”. It is the amount that could be earned in the best alternative use of the entrepreneur’s money and time. It includes
(i) The wage or salary that the entrepreneur could have earned, if he sold his services to others,
(ii) Money rewards for other factors owned by the entrepreneur himself and employed by him in his business and
(iii) The normal return on capital invested by him in his own business. Implicit cost is also known as imputed cost, as it is not possible to assign exact money value to it. It is worked out or imputed on the basis of potential earnings, which the factors of production owned by the firm could get in the next best alternative use.