What is Opportunity Cost

Opportunity cost is commonly defined as the next best alternative. Also, known as the alternative cost, it is the loss of gain which could have been gained if another alternative was chosen. It can also be explained as the loss of benefit due to a change in choice. 

Opportunity cost is an economic concept arising out of the realistic assumption of the scarcity of resources. The limited amount of resources will also limit the number of possibilities for production. As the number of possibilities of production is limited, to produce a given combination of goods, the production of another combination of goods would have to be forgotten. This can be referred to as opportunity cost. 

Opportunity cost is a concept that is widely used by promoters and business analysts to conduct feasibility studies as well as to ascertain policy decisions to be taken. 

Opportunity Cost of Decisions

Every opportunity cost is due to a faulty decision. The better the decision is, the smaller the opportunity cost will be. An opportunity cost can be found in any daily activity. The homework you did not do could be the opportunity cost of sleeping more. Even though you prefer sleeping, the homework makes you more productive and may fetch you more marks. 

In economics, the opportunity cost of decisions generally pertains to the opportunity cost arising due to the decisions of the firm in production. This decision on the choice of production occurs due to the scarcity of resources. For example, a farmer has a fixed area of land in which she cultivates different crops. If the farmer sows rice at a particular time, she can’t produce wheat now as she has already used up her land to produce rice. The gain that the farmer would have earned by cultivating wheat over and above her earnings by sowing rice is her opportunity cost. 

This opportunity cost arose due to two main reasons - the limited area of land with the farmer and her decision to sow rice instead of wheat. If the farmer had an unlimited area of land and unlimited units of labor with her, she could have produced any quantity of both rice and wheat. And if she had decided to produce wheat instead of rice she would have earned more than she does now. 

Calculation of Opportunity Cost

Opportunity cost is the extra return on an alternative available over and above the chosen option. 

Therefore, Opportunity cost = Return from the best alternative – Return from the already selected option

This calculation of opportunity cost has a wide range of applications. Most prominently being used in product planning decisions, the concept of opportunity cost is relevant in many other business scenarios. The calculation method is used when prices paid to factor services are determined and also to calculate economic rent, which is the difference between the actual return to factor services and their supply price. 

The calculation of opportunity cost is not only applicable to the producers. The consumers also use the method of opportunity cost to weigh different consumption bundles among each other. 

Types of Opportunity Costs

There are broadly two types of opportunity costs. They are explicit costs and implicit costs. 

Explicit costs are as the name suggests direct costs that can be identified clearly. The explicit costs are incurred and recorded in the books of accounts. These explicit costs would have to be paid in cash or kind. For example, if a piece of machinery in the firm malfunctions, the repairing cost is explicit. The repairing and reinstalling work will have to be paid in cash and the transaction is charged in the books of accounts as an expenditure. 

Implicit costs are indirect or invisible costs that cannot be directly or easily traced down. The implicit costs affect the firm as the loss of its owned resources. Payments are not usually made as there is no real cost. For example, if in a firm a piece of machinery breaks down as mentioned earlier, in addition to the cost of repairing which is an explicit cost there is also an implicit cost of loss in production. The production in that unit is stalled as the machinery is not working and, in the meantime, other valuable resources like human resources are being wasted. 

What is the Increasing Opportunity Cost?

The concept of increasing opportunity cost is usually seen in the production possibility frontier which shows the possibility of production of different bundles of two goods using a limited amount of resources. The Production Possibility Frontier is concave to the origin and its slope is the opportunity cost. As the PPF is concave to the origin, it shows how the opportunity cost of producing more of one good continuously increases. This increasing nature of opportunity cost is generally explained in terms of the inefficiency of resources when put to work to produce more than one kind of good.

For example, in an economy, steel can be used for making utensils as well as weapons. As more and more steel is used in the production of weapons and less on utensils, the opportunity cost goes on decreasing. This is because the amount of other resources employed in the production of weapons, namely machinery, is fixed and as more and more steel is fed into the limited amount of machinery, it becomes inefficient. 

Introduction to Opportunity cost

It was firstly introduced by the 18th-century economist, Adam Smith. When it comes to opportunity cost, there are three factors that you need to take into account: The value of the option that you're giving up; The likelihood of achieving the desired outcome; And your level of certainty about both options. Opportunity cost is important because it helps us make better decisions and encourages us to think about the future for example when choosing a course of action in business. It can also help determine whether or not pursuing something particular is worth doing based on its potential benefits and what we might have to sacrifice instead.

Opportunity Cost is Important Because

1. It's a measure of the cost of alternatives like sacrificing short-term profits

2. It is used to analyze the potential of an opportunity

3. And it can help you determine whether or not a particular course of action is worth pursuing.

4. It can help you make better decisions

5. It helps to assess opportunity costs and benefits.

6. It encourages you to think about the future.

Here are Some Tips to Study Opportunity Cost

1) Know the Basics- Before starting studying the concept, it is important to have a clear understanding of what it is all about and be familiar with the common terminologies. Which will help you focus on the concept itself.

2) Learn the Rules- There are some rules that you need to follow in order to get accurate results and avoid making mistakes when calculating opportunity costs. You should always use real numbers instead of percentages or fractions for simplifying the calculation process without confusion. When choosing your timing, consider how long an activity takes and when its benefits begin. Avoid cramming - Write down concepts clearly before moving over them so that there won't be any difficulty while practicing later on during exam time!

3) You need to make sure that the correct time period is used. When choosing your timing for opportunity cost calculations, it's important to consider how long an activity takes and when its benefits begin.

4) You should always use real numbers instead of percentages or fractions in order to simplify the calculation and avoid confusion.

5) Avoid Cramming- When it comes to studying, especially for something like opportunity cost where there are a number of complex terms. It is best to make sure that you write them down and understand the concept fully before moving on.

6) Practice Makes Perfect- It is important to practice the calculation because there are a number of different ways to calculate opportunity cost. There are online calculators that you can use or even practice problems to help you better understand the concept.

It is Applied in Various Ways

Opportunity cost is a basic economic principle that applies to businesses as well. It's important to learn and understand the concept in order to make better decisions for your business. The best way to do this is by studying and practicing, which will help you get a clear understanding of how it works.

When making financial decisions, it's important to consider opportunity cost - the amount of money that you have to spend in order to get something else. Opportunity cost is a basic economic principle that applies to businesses as well. Essentially, it's what you give up when pursuing an alternative course of action.