Opportunity Cost Essay

Lets start with a small introduction to the topic Opportunity Cost. Opportunity cost is the cost of any activity measured in terms of the value of the next best alternative forgone (that is not chosen). It is the sacrifice related to the second best choice available to someone, or group, who has picked among several mutually exclusive choices. The opportunity cost is also the â€Å"cost† (as a lost benefit) of the forgone products after making a choice. Opportunity cost is a key concept in economics, and has been described as expressing â€Å"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. Now lets look at Opportunity Cost from the point of production. Opportunity costs may be assessed in the decision-making process of production. If the workers on a farm can produce either one million pounds of wheat or two million pounds of barley, then the opportunity cost of producing one pound of wheat is the two pounds of barley forgone (assuming the production possibilities frontier is linear). Firms would make rational decisions by weighing the sacrifices involved. Looking at Opportunity Cost from the point of Implicit and Explicit Cost. Implicit costs are the opportunity costs that in 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. For example, a firm pays $300 a month all year for rent on a warehouse that only holds product for six months each year. The firm could rent the warehouse out for the unused six months, at any price (assuming a year-long lease requirement), and that would be the cost that could be spent on other factors of production. 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, their opportunity cost is $100. The firm has sacrificed $100, which could have been spent on other factors of production. Now lets look at some real life examples from my life inorder to understand Opportunity Costs better. Opportunity Cost Examples that I myself have been across- I have only Rs 1000 to spend and I have two choices, I can eat at a nice restaurant or buy a good cricket bat instead. I spend my Rs 1000 on buying the cricket bat, then the opportunity cost of that choice is the delicious meal I did not choose and let go. Opportunity Cost also works in regards to time. Eg- I only have two hours of free time. I could either go to a movie or meet a friend of mine. I choose to spend my time at the movie, the opportunity cost of this decision is the time I could have spent enjoying the company of my friend. Here’s another example- When for the first time I decided to invest my saved money lying with me. I had two options that I could do with the money I had. My first choice was either investing in Mutual Funds or leave the money in a Savings Account that earns only 5% per year. I invested in Mutual Funds and it returned 10%, here I’ve benefited from my decision because the alternative would have been less profitable. However, if the Mutual Fund would have returned only 2% when I could have had 5% from the Savings Account, then my opportunity cost would have been (5% – 2% = 3%). To summarize Opportunity Cost, scarcity creates choice, and every choice has value to us. That value can be looked at in terms of benefits and in terms of cost. Value is not always measured in financial terms but sometimes measured in terms of time or enjoyment. The opportunity cost of a choice is what must be given up in order to take an opportunity. It’s not the opportunity we chose, but the value of the next best alternative we didn’t choose. Every major choice has an opportunity cost.