Opportunity Costs

Examples of Opportunity Costs in the following topics:

• Individuals Face Opportunity Costs

  • Individuals face opportunity costs when they choose one course of action over another.
  • The value of the next best choice forgone is called the opportunity cost.
  • Rational individuals will try to minimize their opportunity costs.
  • As economic actors, individuals face opportunity costs as well.
  • This is an opportunity cost.

• Cost

  • The relevant concept of cost is "opportunity cost."
  • Worker earns a wage based on their opportunity cost.
  • The opportunity cost for any use of land is its next highest valued use as well.
  • It is also crucial to note that the entrepreneur also has an opportunity cost.
  • In economics both implicit and explicit opportunity costs are considered in decision making.

• Scarcity Leads to Tradeoffs and Choice

  • When scarce resources are used, actors are forced to make choices that have an opportunity cost.
  • The concept of trade-offs due to scarcity is formalized by the concept of opportunity cost.
  • The opportunity cost of a choice is the value of the best alternative forgone.
  • Similarly, there is an opportunity cost in everything: the opportunity cost of you reading this is what you could be doing with your time instead (say, watching a movie).
  • When scarce resources are used (and just about everything is a scarce resource), people and firms are forced to make choices that have an opportunity cost.

• Absolute Advantage Versus Comparative Advantage

  • Absolute advantage refers to differences in productivity of nations, while comparative advantage refers to differences in opportunity costs.
  • Comparative advantage refers to the ability of a party to produce a particular good or service at a lower opportunity cost than another.
  • Comparative advantage drives countries to specialize in the production of the goods for which they have the lowest opportunity cost, which leads to increased productivity.
  • The opportunity cost of producing 1 unit of clothing is 2 units of food in Country A, but only 0.5 units of food in Country B.
  • Since the opportunity cost of producing clothing is lower in Country B than in Country A, Country B has a comparative advantage in clothing.

• Defining Comparative Advantage

  • A country has a comparative advantage over another when it can produce a good or service at a lower opportunity cost.
  • In economics, comparative advantage refers to the ability of a party to produce a particular good or service at a lower marginal and opportunity cost over another.
  • More specifically, countries should import goods if the opportunity cost of importing is lower than the cost of producing them locally.
  • For another example, if the opportunity cost of producing one more unit of coffee in Brazil is 2/3 units of wheat, while the opportunity cost of producing one more unit of coffee in the United States is 1/3 wheat, then the U.S. should produce coffee, while Brazil should produce wheat (assuming Brazil has the lower opportunity cost of producing wheat).
  • It may or may not have anything to do with opportunity cost or efficiency.

• Introducing the Budget Constraint

  • You have a wide variety of options, but some will provide you with higher opportunity costs than others.
  • The opportunity cost of the former is the high quality foods which have the convenience factor of already being prepared for you while the opportunity cost of the latter is having enough food to feed yourself for the entire month.
  • An opportunity cost is defined as the foregone value of the next best alternative in a given action.
  • You have a wide variety of options, but some will provide you with higher opportunity costs than others.
  • The opportunity cost of the former is the high quality foods which have the convenience factor of already being prepared for you while the opportunity cost of the latter is having enough food to feed yourself for the entire month.

• Economic Costs

  • The opportunity cost includes the salary or wage the individual could be earning if he was employed during his college years instead of being in school.
  • So, the economic cost of college is the accounting cost plus the opportunity cost.
  • Economic cost includes opportunity cost when analyzing economic decisions.
  • So, the economic cost of college is the accounting cost plus the opportunity cost.
  • Economic cost takes into account costs attributed to the alternative chosen and costs specific to the forgone opportunity.

• Difference Between Economic and Accounting Profit

  • Economic profit consists of revenue minus implicit (opportunity) and explicit (monetary) costs; accounting profit consists of revenue minus explicit costs.
  • However, if the firm could have made $50,000 by renting its land and capital, its economic profit would be a loss of $10,000 ($100,000 in revenue - $60,000 in explicit costs - $50,000 in opportunity costs).
  • In contrast, implicit costs are the opportunity costs of factors of production that a producer already owns.
  • Economic profit includes the opportunity costs associated with production and is therefore lower than accounting profit.
  • The biggest difference between economic and accounting profit is that economic profit takes implicit, or opportunity, costs into consideration.

• Types of Costs

  • In economics, the total cost (TC) is the total economic cost of production.
  • It consists of variable costs and fixed costs.
  • Total cost is the total opportunity cost of each factor of production as part of its fixed or variable costs .
  • Variable costs are also the sum of marginal costs over all of the units produced (referred to as normal costs).
  • Economic cost is the sum of all the variable and fixed costs (also called accounting cost) plus opportunity costs.

• Production Outputs

  • Variable costs are only those expenses that are directly tied to the production of more units; fixed costs are not included.
  • Opportunity costs are the cost of an opportunity forgone (and the loss of the benefits that could be received from that opportunity); the cost equals the most valuable forgone alternative.
  • Average total cost is the all expenses incurred to produce the product, including fixed costs and opportunity costs, divided by the number of the units of the good produced.
  • Loss-minimizing condition: The firm's product price is between the average total cost and the average variable cost.
  • If it does not produce goods, the firm suffers a loss due to fixed costs, but it does not incur any variable costs.