Which of the following best explains the relationship between implicit costs, explicit costs, and opportunity costs?

• A. Implicit costs refer to monetary payments, while explicit costs refer to non-monetary sacrifices.
• B. Opportunity cost is always less than the sum of implicit and explicit costs.
• C. Explicit costs are the only component of opportunity cost; implicit costs are unrelated.
• D. Opportunity cost is the sum of implicit and explicit costs incurred when making a choice.

Answer: (D)

Verified step by step guidance

1. Step 1: Understand the definitions of the three key terms: Explicit costs are direct, out-of-pocket payments made by a firm (e.g., wages, rent). Implicit costs represent the value of resources used by the firm for which no direct payment is made (e.g., foregone salary if the owner works in their own business). Opportunity cost is the total cost of choosing one option over another, including both explicit and implicit costs.
2. Step 2: Recognize that explicit costs are monetary payments, while implicit costs are non-monetary but still represent real economic costs because they reflect foregone alternatives.
3. Step 3: Recall that opportunity cost measures the full cost of a decision by combining both explicit and implicit costs, as it captures all resources sacrificed to pursue a particular choice.
4. Step 4: Analyze the incorrect options: The statement that implicit costs are monetary payments is false; they are non-monetary. The claim that opportunity cost is always less than the sum of implicit and explicit costs is incorrect because opportunity cost equals their sum. The idea that explicit costs are the only component of opportunity cost ignores implicit costs, which is also incorrect.
5. Step 5: Conclude that the best explanation is that opportunity cost equals the sum of implicit and explicit costs incurred when making a choice, as this fully captures the economic cost of the decision.