Opportunity cost

The opportunity cost of an action is the value of the benefit expected from the next best foregone alternative. It is a derivative concept which arises due to the scarcity of resources (for production) or goods and services (for consumption) which necessitates the making of choice between competing alternative uses – where more of a commodity is produced or consumed reducing the production or consumption of another.
From the standpoint of an entrepreneur, the opportunity cost of deciding to organize land, labour and capital in the manufacture of fertilizer in a factory is the value of organizing the same resources in establishing and running a private school; a farmer with one acre of land may choose to either produce maize, wheat or barley whose return/incomes are 50,000 shillings, 60,000 shillings and 40,000 shillings respectively – the opportunity cost of producing wheat in this case, would be the value of the maize output which is the next best alternative forgone (i.e. Sh.50,000). If all the land is devoted to production of wheat then no other crop can be produced on the same piece of land – the farmer can decide to reduce the acreage under wheat in order to produce another crop like maize, in which case, the opportunity cost of this portion of maize is the value of the specific units of wheat foregone.
A CPA course student could have Sh.200 and requires both economics and FA I text books, each costing Sh.200. This amount (Sh.200) is certainly not enough (such that the two items are mutually exclusive) and therefore calls for the student to choose between the two alternatives, that is, to either buy the economics textbook and forego the FA text book or vice versa. Assuming the student opts to buy the economics textbook, the opportunity (economic) cost is the value of the benefit forgone not buying the FA textbook.
Accounting profit net of opportunity cost gives economic profit, opportunity cost being an implicit cost.

(Visited 7 times, 1 visits today)
Share this:

Written by 

Leave a Reply