Scribd
Upload
80 views5 pages

Basic Principles of Economics

mba

Uploaded by

mba department
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
80 views5 pages

Basic Principles of Economics

mba

Uploaded by

mba department
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
You are on page 1/ 5

Opportunity cost principle is related and applied to scarce resource.

When there are alternative uses of scarce resource, one should know
which best alternative is and which is not. We should know what gain
by best alternative is and what loss by left alternative is.
The income or benefit foregone as the result of carrying out a
particular decision, when resources are limited or when mutually
exclusive projects are involved.

Definitions
— In the words of Left witch, "Opportunity cost of a particular product
is the value of the foregone alternative products that resources used in
its production, could have produced."
Opportunity cost is not what you choose when you make a choice —it
is what you did not choose in making a choice. Opportunity cost is
the value of the forgone alternative — what you gave up when you got
something.
Example 1:
If a person is having cash in hand Rs. 100000/-, he may think of two
alternatives to increase cash.
Option 1: Investing in bank. We will get returns amount 10000/-
Option2: Investing in business. We get returns amount 17000/-
Generally we chose the option 2 because we will get more returns than
the option 1. Here the option 1 is the opportunity cost, that what we
have not chosen.
Example 2:
I have a number of alternatives of how to spend my Friday night: I can
go to the movies; I can stay home and watch the baseball game on TV,
or go out for coffee with friends. If I choose to go to the movies, my
opportunity cost of that action is what I would have chosen if I had not
gone to the movies - either watching the baseball game or going out
for coffee with friends. Note that an opportunity cost only considers
the next best alternative to an action, not the entire set of
alternatives.
The opportunity cost of a decision is based on what must be given up
(the next best alternative) as a result of the decision. Any decision that
involves a choice between two or more options has an opportunity
cost.
The main objective of incremental principle is maximization of profits
or in other words to raise the profits in the business
General rule:
By increasing in the production, the total cost of the product raises and
simultaneously profit also rises.
Practicality in the business:
How much extra we should produce to get the best profits and how
much extra cost would be incurred for the extra production.
Incremental concept involves estimating the impact of decision
alternatives on costs and revenues, emphasizing the changes in total
cost and total revenue resulting from changes in prices, products,
procedures, investments or whatever else may be at stake in the
decisions. The two basic components of incremental reasoning are:
1. Incremental cost
2. Incremental revenue.
Incremental cost may be defined as the change in total cost resulting
from a particular decision. Incremental revenue is the change in total
revenue resulting from a particular decision.
 Incremental concept /principle
The incremental principle may be stated as follows: A decision is a
profitable one if—
1. it increases revenue more than cost
2. it decreases some costs to a greater extent than it increases
others
3. it increases some revenues more than it decreases others and
4. it reduces cost more than revenues.
Suppose a firm gets an order that brings additional revenue of Rs
3,000. The cost of production from this order is:
Rs. Labour 800
 Materials 1,300
 Overheads 1,000
 Selling and administration expenses 700
Full cost 3,800
At a glance, the order appears to be unprofitable. But suppose the firm
has some idle capacity that can be utilised to produce output for new
order. There may be more efficient use of existing labour and no
additional selling and administration expenses to be incurred. Then the
incremental cost to accept the order will be:
Rs.
 Labour 600
 Materials 1,000
 Overheads 800
Total incremental cost 2,400
Incremental reasoning shows that the firm would earn a net profit of Rs
600 (Rs 3,000 – 2,400), though initially it appeared to result in a loss of
Rs 800. The order should be accepted.
A simple situation in everyday life provides an example of incremental
analysis. Consider a worker leaving work to travel home. Groceries are
required and can be purchased at slightly higher prices at a store on
the way from the work place to the home, or at lower prices by driving
to a store 3 miles (4.82 km) from home. The worker decides to
purchase the groceries on the way home since no incremental travel
costs are involved, and the incremental difference in grocery prices will
be less than the value the worker places on the time and other costs
required to drive to the more distant store.
3. Principle of time perspective:

“a decision by the firm should take into account of both short-run


and long-run effects on revenues and cost & maintain the right
balance between the long run and short run.

According to the principle of time perspective, a manger/decision


maker should give due emphasis, both to short-term and long-term
impact of his decisions, giving apt significance to the different time
periods before reaching any decision. Short-run refers to a time period
in which some factors are fixed while others are variable. The
production can be increased by increasing the quantity of variable
factors.

While long-run is a time period in which all factors of production can


become variable. Entry and exit of seller firms can take place easily.
From consumers point of view, short-run refers to a period in which
they respond to the changes in price, given the taste and preferences
of the consumers, while long-run is a time period in which the
consumers have enough time to respond to price changes by varying
their tastes and preferences.

Eg: ABC is a firm engaged in continuous production of X commodities


(long run). In the production process, it is having daily an ideal time
(free time) for few hours. In that ideal time, firm can take an order for
manufacturing other similar goods instead of wasting time. By
manufacturing goods in the ideal time firm does not incur any extra
fixed cost like (salaries, wages and rent and) because it is constant. So
the fixed cost is absent in the production which is done in the ideal
time. Generally in production of goods, fixed and variable cost (raw
material & labour) is present. However, here the production made in
the ideal time, fixed cost is absent. This shows the cost is reduced in
production that is made in the ideal time. Investment made in the
business can also be recovered very quickly and in short time.

For example,

Suppose there is a firm with a temporary idle capacity. An order for


5000 units comes to management’s attention. The customer is willing
to pay Rs 4/- unit or Rs.20000/- for the whole lot but not more. The
short run incremental cost(ignoring the fixed cost) is only Rs.3/-. There
fore the contribution to overhead and profit is Rs.1/- per unit (Rs.5000/-
for the lot)Analysis:From the above example the following long run
repercussion of the order is to be taken into account:
1. If the management commits itself with too much of business at
lower price or with a small contribution it will not have sufficient
capacity to take up business with higher contribution.
2. If the other customers come to know about this low price, they
may demand a similar low price.Such customers may complain of
being treated unfairly and feel discriminated against.

In the above example it is therefore important to give due


consideration to the time perspectives. “a decision should take into
account both the short run and long run effects on revenues and costs
and maintain the right balance between long run and short run
perspective”.

Here the principle of time perspective applies, where maintains right


balance between long run and short-run markets.

You might also like

pFad - Phonifier reborn

Pfad - The Proxy pFad of © 2024 Garber Painting. All rights reserved.

Note: This service is not intended for secure transactions such as banking, social media, email, or purchasing. Use at your own risk. We assume no liability whatsoever for broken pages.


Alternative Proxies:

Alternative Proxy

pFad Proxy

pFad v3 Proxy

pFad v4 Proxy