In microeconomic theory, opportunity cost is the loss or the benefit that could have been enjoyed if the best alternative choice was chosen.
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.
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
Explicit costs are the direct costs 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.
Examples are as follows:
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
Implicit costs (also referred to as Implied, Imputed or Notional costs) are the opportunity costs of utilizing 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.
Examples of implicit costs regarding production are mainly resources contributed by a business owner which includes:
Human labor
Infrastructure
Time
__________________________________________________________________________________
Comments