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Imputed cost, also referred to as opportunity cost, is a concept based on an economic theory, which basically states that to obtain anything one must give up something in return. For example, to get a full-time four year college education, one may need to forgo the opportunity of working full time and earning $20,000 US Dollars (USD) per year in that period. The $20,000 USD is the imputed cost. Among other concepts, the imputed cost concept is essential when computing economic profit. This is derived by taking the net accounting profit or loss and deducting the imputed cost.
The theory behind imputed cost is that of trade-off. In essence, the trade-off theory states that virtually everything comes with some type of price tag. For example, to create and maximize wealth, some firms may engage in activities that harm the environment. To combat this, governments may implement environmental protection laws, which may curtail pollution, and in turn humans may greatly benefit from a less polluted environment. The imputed cost associated with this, however, may be the increase in cost of production for the firms, which may result in less profits and less job creation, among other results.
As one of the various concepts of economics, imputed cost is associated with many other concepts and practices in economics and business. These include concepts like cost-benefit analysis, economic profit, and hobby loss. Cost-benefit analysis, in essence, is the act of making business decisions after considering all viable options and weighing all the direct and indirect pros and cons. Generally, after conducting such an analysis a firm will choose the option that serves its purpose the most.
Economic profit is different from accounting profit, because in its calculation it considers both explicit and implicit costs, whereas accounting profit is only concerned with the tangible or explicit costs. To illustrate, for example, consider a firm that buys a machine whose main purpose is to produce specific items. Suppose the firm rents the machine, which brings in an annual net income of $20,000 USD. On the other hand, however, if the firm had gone with the alternative, that of producing the items and selling them itself, it would have made a net income of $25,000 USD. In such a scenario, the firm's economic loss would be $5,000 USD, and so the firm would have earned no economic profit.
Most often, people engage in activities from which they derive personal enjoyment. If these activities do not produce an income on a regular basis, then they are considered hobbies. Any loss produced while engaged in these activities is referred to as a hobby loss and cannot be claimed when filing tax returns. Theoretically, hobby losses are compounded on by imputed costs. That is, for example, an individual may incur a loss through a hobby, whereas that pastime would have been spent earning employment wages in the first place.
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