Q: 38 What are Opportunity COSTS???

Assignment – 1 (MBA 1-B)

Accounting for Management

Q: 38 What are Opportunity COSTS???

Introduction

Opportunity cost is the cost of any activity measured in terms of the best alternative forgone. It is the sacrifice related to the second best choice available to someone who has picked among several mutually exclusive choices^. It is a key concept in economics. It has been described as expressing "the basic relationship between scarcity and choice." The notion of opportunity cost plays a crucial part in ensuring that scarce resources are used efficiently. Thus, 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 opportunity costs.

The concept of an opportunity cost was first developed in 1914 by Friedrich von Wieser in his book”Theories der gesellschaftlichen Wirtschaft”.

Definition

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.

The forgone cost is known as opportunity cost. It is also known as the value of the best available alternative which can be resulted after making a decision. Opportunity cost is very important in decision making of the companies because companies need to select the best alternatives available to them and if a company is not able to achieve its aim then it becomes the opportunity cost for the company. In other words, opportunity cost is resulted when the company selects one alternative over another.

For example:- if you have two options to start a business; either to go for a gift shop or to start a small food stalls. If you select one option then the other will become your opportunity cost.

Another example of opportunity costs are:

v Giving up your favorite movie to study (in order to get good grades). The opportunity cost is the movie that has been forgone.

v I have a number of alternatives of how to spend my Friday night: I can go to the movies; I can stay home and watch the baseball game on TV, or go out for coffee with friends. If I choose to go to the movies, my opportunity cost of that action is what I would have chose if I had not gone to the movies - either watching the baseball game or going out for coffee with friends. Note that an opportunity cost only considers the next best alternative to an action, not the entire set of alternatives.

Discussion

Opportunity costs in consumption

Opportunity cost is assessed in not only monetary or material terms, but also in terms of anything which is of value. For example, a person who desires to watch each of two television programs being broadcast simultaneously, and does not have the means to make a recording of one, can watch only one of the desired programs. Therefore, the opportunity cost of watching Dallas could be not enjoying the other program (e.g. Dynasty). Of course, if an individual records one program while watching the other, the opportunity cost will be the time that the individual spends watching one program versus the other. In a restaurant situation, the opportunity cost of eating steak could be trying the salmon. For the dinner, the opportunity cost of ordering both meals could be twofold - the extra $20 to buy the second meal, and his reputation with his peers, as he may be thought gluttonous or extravagant for ordering two meals. A family might decide to use a short period of vacation time to visit Disneyland rather than doing household improvements. The opportunity cost of having happier children could therefore be a remodeled bathroom.

Opportunity costs in production

Opportunity costs may be assessed in decision-making process of production. If the workers on a farm can produce either 1 million pounds of wheat or 2 million pounds of barley, then the opportunity cost of producing 1 pound of wheat is the 2 pounds of barley forgone. Firms would make rational decisions by weighing the sacrifices involved.

Explicit costs

Explicit costs are opportunity costs that involve direct monetary payment by producers. The opportunity cost of the factors of production not already owned by a producer is the price that the producer has to pay for them. For instance, a firm spends $100 on electrical power consumed; the opportunity cost is $100. The firm has sacrificed $100, which could have been spent on other factors of production.

Implicit costs

Implicit costs are by contrast, the opportunity costs that involve only factors of production that a producer already owns. They are equivalent to what the factors could earn for the firm in alternative uses, either operated within the firm or rent out to other firms.

Conclusion

The consideration of opportunity costs is one of the key differences between the concepts of economic cost and accounting cost. Assessing opportunity costs is fundamental to assessing the true cost of any course of action. In the case where there is no explicit accounting or monetary cost (price) attached to a course of action, or the explicit accounting or monetary cost is low, then, ignoring opportunity costs may produce the illusion that its benefits cost nothing at all. The unseen opportunity costs then become the implicit hidden costs of that course of action.Note that opportunity cost is not the sum of the available alternatives when those alternatives are, in turn, mutually exclusive to each other. The opportunity cost of the city's decision to build the hospital on its vacant land is the loss of the land for a sporting center, or the inability to use the land for a parking lot, or the money which could have been made from selling the land, as use for any one of those purposes would preclude the possibility to implement any of the other. It is also the cost of the forgone products after making a choice. Opportunity cost has been seen as the foundation of the marginal theory of value as well as the theory of time and money.

References

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SUBMITTED TO: - PRO. GURDEEPAK SINGH

SUBMITTED BY: - PAWAN KUMAR

MBA 1(1^st Semester)

Section - B