Opportunity cost, also referred to as true cost, by definition is the g services forgone by employing the resources in their best or most profitable alternatively simply means an expression of cost in forgone alternatives. Opportunity cost is a concept that is widely used in economics and business, but it is not always fully understood by everyone. The opportunity cost is the cost of an alternative that must be forgone in order to pursue a certain action. It is the cost of the next best alternative that could have been chosen instead. In other words, opportunity cost is the cost of a missed opportunity.
In this blog post, we will discuss the concept of opportunity cost in detail. We will explain what it is, why it is important, how to calculate it, and provide some real-world examples.
What is Opportunity Cost?
Opportunity cost is the value of the best alternative that is forgone as a result of making a certain decision. It is the value of what is given up in order to make a particular choice. Opportunity cost is often referred to as the \”hidden cost\” because it is not always obvious or easy to calculate.
For example, if you have $10 and you decide to spend it on a cup of coffee, the opportunity cost is the value of the next best alternative that you could have chosen with that $10. If the next best alternative was to save the $10, then the opportunity cost of buying the coffee is the value of the savings.
Opportunity cost is an important concept because it helps us to understand the true cost of a decision. It is not just the immediate cost that needs to be considered, but also the cost of the forgone opportunity. This is particularly important in business and investment decisions, where the opportunity cost can be significant.
How to Calculate Opportunity Cost
The calculation of opportunity cost can be complex, as it involves comparing the value of different options. However, there are some basic steps that can be followed to calculate opportunity cost:
- Identify the decision that needs to be made: This could be a decision to invest in a particular project or to spend money on a particular item.
- Identify the alternatives: What are the other options that could be chosen instead of the chosen option? For example, if the decision is to invest in a particular project, what are the other investment options available?
- Determine the costs and benefits of each alternative: What are the costs and benefits associated with each option? This may involve estimating future cash flows, assessing risks, and considering other factors.
- Calculate the opportunity cost: The opportunity cost is the value of the best alternative that is forgone. This can be calculated by subtracting the value of the chosen option from the value of the best alternative.
Real-World Examples of Opportunity Cost
Let\’s take a look at some real-world examples of opportunity cost:
Example 1: Investing in Stocks vs Bonds
Suppose you have $10,000 to invest and you are trying to decide whether to invest in stocks or bonds. Stocks offer a higher potential return but also come with higher risks, while bonds offer a lower return but are less risky.
The opportunity cost of investing in stocks is the potential return that could have been earned by investing in bonds. If the return on bonds is 4% per year and the return on stocks is 8% per year, then the opportunity cost of investing in stocks is 4%.
Example 2: Starting a Business
Suppose you are considering starting a business and you have two options: starting your own business or buying an existing business. Starting your own business offers the potential for greater rewards, but also comes with higher risks and uncertainties. Buying an existing business offers a more stable income stream but also requires a larger upfront investment.
The opportunity cost of starting your own business is the potential income that could have been earned by buying an existing business. If the existing business generates an income of $50,000 per year and starting your own business has the potential to generate an income
In other words, opportunity cost is the satisfaction of one want at the expense of another want. It refers to the wants left unsatisfied in order to satisfy another pressing need
Money cost on the other hand the amount of money spent to p: particular good or service. It can described as the money value of a colt is the cost in terms of legal tender (currency) value.
For example, a farmer has 6100 two pressing wants, namely to buy a o a hoe, each of which costs 6100. The farmer has to choose to buy one of the items expense of the other as a result of his available resources.
If the farmer decides the cutlass and forgo the hoe, N100 is thus the money cost of the cutlass he bought while opportunity cost of the cutlass is the hoe he failed to buy with the same amount of money.
Therefore, the opportunity cost of any item is referred to as the alternative forgone in order to buy an item while money cost is the amount of money spent in buying such item.
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Explicit costs refer to the expenses that a company or an individual pays for a particular item or service. These costs are direct and easy to measure since they involve actual payment of money. Explicit costs are different from implicit costs, which are indirect costs that are not immediately apparent. Examples of implicit costs include lost opportunities, foregone profits, and time spent doing a particular activity. This blog post will focus on explicit costs and their various forms, types, and examples.
Forms of Explicit Costs
Explicit costs take various forms depending on the nature of the expense. The most common forms of explicit costs include:
- Direct Costs
Direct costs are expenses that can be attributed directly to a particular product, service, or project. These costs are usually variable and are directly proportional to the level of production or the size of the project. Examples of direct costs include raw materials, labor, equipment, and transportation costs.
- Indirect Costs
Indirect costs are expenses that are not directly attributable to a particular product, service, or project. These costs are fixed and do not vary with the level of production or size of the project. Examples of indirect costs include rent, utilities, insurance, and administrative costs.
- Sunk Costs
Sunk costs are expenses that have already been incurred and cannot be recovered. These costs are not relevant in decision-making since they are not future costs. Examples of sunk costs include research and development costs, advertising costs, and expenses incurred on a failed project.
Types of Explicit Costs
Explicit costs can be classified into various types depending on the context of the expense. The most common types of explicit costs include:
- Accounting Costs
Accounting costs refer to the actual outlay of cash or other resources to acquire a particular item or service. These costs are usually recorded in the financial statements of a company or individual.
- Economic Costs
Economic costs are the total costs incurred by a company or individual in the production of goods or services. Economic costs include both explicit and implicit costs. Implicit costs are the opportunity costs of using resources to produce a particular product or service.
- Opportunity Costs
Opportunity costs refer to the value of the next best alternative foregone when a particular choice is made. Opportunity costs are usually implicit costs and are not reflected in the financial statements of a company or individual.