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As a representation of the relationship between scarcity and choice, the objective of opportunity cost is to ensure efficient use of scarce resources. It incorporates all associated costs of a decision, both explicit and implicit. Opportunity cost also includes the utility or economic benefit an individual lost, it is indeed more than the monetary payment or actions taken. As an example, to go for a walk may not have any financial costs imbedded to it. Yet, the opportunity forgone is the time spent walking which could have been used instead for other purposes such as earning an income.
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However time spent after an income might have health problems like in presenteeism where instead of taking a sick day one avoids it for salary or to be seen as active.
Regardless of the time of occurrence of an activity, if scarcity was non-existent then all demands of a person are satiated. It’s only through scarcity that choice becomes essential which results in ultimately making a selection and/or decision.
Sacrifice is a given measurement in opportunity cost of which the decision maker forgoes the opportunity of the next best alternative. In other words, to disregard the equivalent utility of the best alternative choice to gain the utility of the best perceived option. If there were decisions to be made that require no sacrifice then these would be cost free decisions with zero opportunity cost.
Types of opportunity costs
Explicit costs are the direct cost of an action, executed either through a cash transaction or a physical transfer of resources. In other words, explicit opportunity costs are the out-of-pocket costs of a firm. With this said, these particular costs can easily be identified under the expenses of a firm's income statement to represent all the cash outflows of a firm.
- Land and infrastructure costs
- Operation and maintenance costs - wages, rent, overhead, materials
Scenarios are as follows:
- If a person leaves work for an hour and spends $200 on office supplies, then the explicit costs for the individual equates to the total expenses for the office supplies of $200.
- If a printer of a company malfunctions, then the explicit costs for the company equates to the total amount to be paid to the repair technician.
Implicit costs (also referred to as Implied, Imputed or Notional costs) are the opportunity costs of utilising resources owned by the firm that could be used for other purposes. These costs are often hidden to the naked eye and aren’t made known. Unlike explicit costs, implicit opportunity costs are normally corresponding to intangibles. Hence, they cannot be clearly identified, defined or reported. In terms of factors of production, implicit opportunity costs allow for depreciation of goods, materials and equipment that ensure the operations of a company.
- Human labour
Scenarios are as follows:
- If a person leaves work for an hour to spend $200 on office supplies, and has an hourly rate of $25, then the implicit costs for the individual equates to the $25 that he/she could have earned instead.
- If a printer of a company malfunctions, the implicit cost equates to the total production time that could have been utilized if the machine did not break down.
Excluded from opportunity cost
Sunk costs (also referred to as historical costs) are costs that have been previously sustained and cannot be recovered. Since sunk costs are costs that have been incurred, they remain unchanged by both present and future action. Decision makers who recognise the insignificance of sunk costs then understand that the "consequences of choices cannot influence choice itself".
A scenario is given below:
A company used $5,000 for marketing and advertising on its music streaming service to increase exposure to target market and potential consumers. In the end, the campaign proved unsuccessful. The sunk cost for the company equates to the $5,000 that was spent on the market and advertising means. This expense is to be ignored by the company in its future decisions, and highlights that no additional investment should be made.
Seeking a certain profit, might have implicit costs such as: health, ecological, or other costs. Many of those costs may not be undergone directly or rightafter, they may also not be undergone by the one from which this cost comes. (Such as a company that pollutes, the costs may not be undergone by the company's accountance. But could be undergone by many external persons (local pollution) or actors or everyone (global warming).
Smoking for a person might have higher costs such as health costs, for the economy it may generates direct losses or prevalence of health problems which could harm economy. The tobacco sectors generates losses for many sectors. However for the tobacco industry no cost might be undergone. Withdrawing smoking may reduce hidden costs. Like having a walk instead of smoking could be beneficial to one's health. Choosing to work at half-time may allow for more rest for a sick person.
Externalities are a kind of costs generate from an economic agent to other ones restauration sector might be growing but obesity may generate a cost in many domains monetary or not (more difficulty to recruit fit firemen). Some sectors are growing extensively from a such cost (private or not). Dentists are needed partly because both sugary foods and tobacco generate them work and demand.
Plane travels may harm by contributing to global warming and air pollution which harms many sectors, agriculture, natural landscape tourism etc. Short term profit may lead to high costs later. Refusing to invest in infrastucture or mainteance for a company may lead to a loss of customers.
- Austrian School
- Best alternative to a negotiated agreement
- Budget constraint
- Economic value added
- Fear of missing out
- Lucrum cessans
- Opportunity cost of capital
- Production-possibility frontier
- Reduced cost aka 'opportunity cost' in linear programming
- There ain't no such thing as a free lunch
- Time management
- You can't have your cake and eat it
- Perverse subsidies
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