Concept and Meaning of Opportunicty Cost
The problem of scarcity and choice gives birth to the concept of opportunity cost. It means the concept of scarcity and choice is also related to the economic problems of scarcity and choice.
Resources are scarce and at the same time, they can be put into alternative uses. Therefore, as economic agent chooses the best one then they need to give up the second-best alternative. The benefit that economic agents sacrifice while getting the best alternative is known as opportunity cost. Thus, opportunity cost is defined as the loss of income due to opportunity foregone. In the next words, opportunity cost refers to what input could earn in its next best alternative job. The opportunity cost arises due to scarcity and alternative uses of resources.
For example, suppose a farmer has a fixed piece of land and he can produce either potato or onion in the coming year. If he thinks that he will produce more onion by sacrificing the production of potatoes. Here we can assert that the opportunity cost of producing onion is the foregone output of potatoes.
The concept of opportunity cost is built on the scarcity and alternative uses of resources. Because of the scarcity of resources, economies are not able to produce many types of goods at once. So, if an economy produces one type of good it must give up another commodity. Thus, opportunity cost is the expected return from the next best and forgone use of resources because of limited and alternative uses of resources. Opportunity cost is alternatively named as alternative cost or displacement cost.
Uses of Opportunity Cost
The concept of opportunity cost plays a critical role in policy formulation and decision-making regarding projects and new investments. The cost-benefit analysis as a tool of project analysis is based on the concept of opportunity cost.
In economics, we assume that every economic agent is rational and self-guided towards the fulfillment of their optimization. While fulfilling the goals/optimization goals by economic agents they must make efficient decisions utilizing the scarce resources. The efficiency of any decision can be observed in terms of its opportunity cost also. If any decision taken by a consumer has a huge opportunity cost, then her/her decision is regarded as an irrational or inefficient decision. Similarly, for another individual, if he thinks he had made the best decision then it means that the opportunity cost of that specific decision is low.
The concept of opportunity cost is also useful in the identification of the best production scheme for the producer as it demonstrates a direction and provides guidance while deciding which good to produce.
The concept of Opportunity cost is also needed to make investment decisions. Answer to the questions like where to invest may be obtained by measurement of the opportunity cost of a particular investment opportunity/alternative.
Therefore, applying the concept of opportunity cost, the consumer can consume the utility-maximizing product, the producer can produce profit-maximizing output, an investor can invest in most return generating opportunities and the government can expend on welfare-maximizing projects.
Summary: Uses of the Concept of Opportunity Cost
- Opportunity cost helps to choose what to produce.
- It helps in making decisions concerning investment
- Opportunity cost also helps in defining the efficiency of decisions.
- It helps in the cost-benefit analysis of public projects.