OPPORTUNITY COST

Opportunity costs represent the benefits an individual, investor or

business misses out on when choosing one alternative over another.
A benefit, profit, or value of something that must be given up to acquire or
achieve something else. Since every resource (land, money, time, etc.) can be
put to alternative uses, every action, choice, or decision has an associated
opportunity cost.
Opportunity costs are fundamental costs in economics, and are used in
computing cost benefit analysis of a project. Such costs, however, are not
recorded in the account books but are recognized in decision making by
computing the cash outlays and their resulting profit or loss.

Opportunity cost is a key concept in economics, and has been described as

expressing "the basic relationship between scarcity and choice". The notion of
opportunity cost plays a crucial part in attempts to ensure that scarce
resources are used efficiently. Opportunity costs are not restricted
to monetary or financial costs: the real cost of output forgone, lost time,
pleasure or any other benefit that provides utility should also be considered an
opportunity cost. The opportunity cost of a product or service is
the revenue that could be earned by its alternative use. In other words,
opportunity cost is the cost of the next best alternative of a product or service.
The meaning of the concept of opportunity cost can be explained with the help
of following examples:
(1) The opportunity cost of the funds tied up in one's own business is the
interest (or profits corrected for differences in risk) that could be earned on
those funds in other ventures.
(2) The opportunity cost of the time one puts into his own business is the
salary he could earn in other occupations (with a correction for the relative
psychic income in the two occupations).
(3) The opportunity cost of using a machine to produce one product is the
earnings that would be possible from other products.
(4) The opportunity cost of using a machine that is useless for any other
purpose is nil, since its use requires no sacrifice of other opportunities.
Thus opportunity cost requires sacrifices. If there is no sacrifice involved in a
decision, there will be no opportunity cost. In this regard the opportunity costs
not involving cash flows are not recorded in the books of accounts, but they
are important considerations in business decisions.
Calculating opportunity costs:
To find the opportunity cost of any good X in terms of the units of Y given up,
we use the following formula:
Opportunity cost of each unit of good X = (Y1−Y2)÷(X1−X2) units of good Y
For example, suppose we knew that the following table represented all of the
possible combinations of iPads and Apple Watches that could be produced.

Number of Apple
Watches Number of iPads

0 5

2 4

4 3

6 2

8 1

10 0
If a producer is producing 6 Apple Watches and 2 iPads, but wants to make one
more iPad, they can instead produce 4 Apple Watches and 3 iPads:
Opportunity cost of one iPad= (6−4) ÷ (3−2) Apple Watches
=2÷1 Apple Watches
=2 Apple Watches
Note that opportunity costs are always expressed in terms of the good that is
given up.
EXPLICIT AND IMPLICIT COST
Explicit cost:
Explicit cost is called outlay cost and refers to any payment to an outsider and
is reflected in a company’s book of account. They are out-of-pocket costs for a
firm.
For example, payments for wages and salaries, rent, utilities or raw materials.
Implicit cost:
Implicit cost is opportunity cost and is not taken into consideration by the
accountant. The cost of resources already owned by the firm, often for small
businesses that could have been put to some other use. Implicit costs also
allow for depreciation of goods, materials, and equipment that are necessary
for a company to operate.
For example, an entrepreneur who owns a business could use her labor to earn
income at a job or using the ground floor of a home as a retail store.
Example of an explicit and implicit costs:
An employee could take a vacation and travel. The explicit costs would include
travel expenses, the cost of a hotel room, and costs related to entertainment.
The implicit costs relate to the tradeoff, namely the wages that the employee
could have earned if the vacation was not taken.
THE PRODUCTION POSSIBILITIES CURVE
The production possibilities curve (PPC) is also known as production
possibilities frontier (PPF).
The Production Possibilities Curve (PPC) is a model used to show the tradeoffs
associated with allocating resources between the production of two goods.
The PPC can be used to illustrate the concepts of scarcity, opportunity cost,
efficiency, inefficiency, economic growth, and contractions.

A production possibility curve measures the maximum output of two goods

using a fixed amount of input. The input is any combination of the four factors
of production. They are land and other natural resources, labor, capital goods,
and entrepreneurship. The manufacture of most goods requires a mix of all
four.

Each point on the curve shows how much of each good will be produced when
resources shift from making more of one good and less of the other.

Points on the interior of the PPC are inefficient, points on the PPC are efficient,
and points beyond the PPC are unattainable. The opportunity cost of moving
from one efficient combination of production to another efficient combination
of production is how much of one good is given up in order to get more of the
other good.
The shape of the PPC also gives us information on the production technology
(in other words, how the resources are combined to produce these goods). The
bowed out shape of the PPC in Figure 1 indicates that there are increasing
opportunity costs of production. The bowed in shape of the PPC in Figure 2
shows there are decrease in opportunity costs of production. And figure 3
represents constant opportunity costs of production.
We can also use the PPC model to illustrate economic growth, which is
represented by a shift of the PPC. Figure A illustrates an agent that has
experienced economic growth. Combinations that were once impossible, are
now on the new PPC, thanks to the increase in resources or technology. Figure
B indicates that agent has experienced economic contraction due to decrease
in resources or technology.