# INTRODUCTION (opportunity cost as an economic tool(TAKING REAL LIE SITUATIONS))

1.
WHAT IS OPPORTUNITY COST ?

Opportunity cost is the value of the next best thing you give up whenever you make
a decision. It is "the loss of potential gain from other alternatives when one
alternative is chosen".

The idea of an opportunity cost was first begun by John Stuart Mill. The utility
has to be more than the opportunity cost for it to be a good choice in economics.

For example, opportunity cost is how much leisure time we give up to work. Because
leisure and income are both valued, we have to decide whether to work, or do what
we want. Going to work implies more income but less leisure. Staying at home is
more leisure yet less income.

Another example is deciding to stop work to go back to university. By choosing to

go to university, your opportunity cost is losing your job and your pay check. Even
though going back to university has a big opportunity cost, many people think it is
a good decision because increased education gives you more job opportunities.
And in other words, opportunity cost can be termed as cost of forgone alternatives
or cost of shifting from one opportunity to the other.

2.
DEFINITION OF OPPORTUNITY COST

"Opportunity cost is the value of the next best alternative that is forgone".
when making a decision. It represents the benefits, resources, or opportunities
that are sacrificed by choosing one option over another. In other words, it is the
cost of what you have to give up in order to pursue a certain course of action.
Opportunity cost helps in evaluating the trade-offs involved in decision-making,
ensuring more efficient resource allocation by considering not only the direct
outcomes but also what is lost by not selecting the alternative.

The phrase "opportunity cost is the value of the next best alternative forgone"
means that when you make a decision, you give up the chance to benefit from the
next best option available to you.
For example,
if you spend money on a vacation, the opportunity cost is what you could have used
that money for instead, such as saving it or investing it elsewhere. Essentially,
every decision involves a trade-off, and the opportunity cost measures the value of
what you lose when you choose one thing over another. It helps you understand the
hidden cost of your choices.

3. DEFINITION OF
OPPORTUNITY COST IN ECONOMICS

1. In microeconomic theory, the opportunity cost of a choice is the value of

the best alternative forgone where, given limited resources, a choice needs to be
made between several mutually exclusive alternatives. Assuming the best choice is
made, it is the "cost" incurred by not enjoying the benefit that would have been
had if the second best available choice had been taken instead.

For instance, if you have rs.1lakh and choose to invest it in stocks rather than in
a savings account, the opportunity cost is the interest you would have earned from
the savings account. Similarly, if you decide to spend your weekend studying for an
exam instead of going out with friends, the opportunity cost includes the enjoyment
and relaxation you miss out on with your friends.

By considering opportunity cost, individuals and businesses can make more informed
choices, ensuring they allocate their resources—such as time, money, and effort—
more efficiently. Understanding what is sacrificed helps to evaluate decisions
better and optimize outcomes in various scenarios.

Examples:
Choosing to buy a new laptop instead of going on a vacation means giving up the
experience and enjoyment of traveling.
A farmer deciding to plant wheat instead of corn may miss out on the potential
higher profits from corn if it turns out to be more lucrative that season.

2. In modern economic analysis, the factors of production are scarce as

compared to the wants. Therefore, when society uses a certain factor in the
production of a specific commodity, then it forgoes other commodities for which it
could use the same factor. This led to the idea of an opportunity cost (OC). In
other words, opportunity costs are the costs of the next best alternative forgone.
Therefore, we can deduce two important aspects:

The opportunity costs of a product are only the best alternative forgone and not
any other alternative. These costs are viewed as the next-best alternative goods
that we can produce with the same value of factors which are more or less the same.

4. TYPES OF
OPPORTUNITY COST

1. EXPLICIT COSTS
2. IMPLICIT COSTS

1. EXPLICIT COSTS

Explicit costs are the direct costs of an action (business operating costs or
expenses), executed through either a cash transaction or a physical transfer of
resources. In other words, explicit opportunity costs are the out-of-pocket costs
of a firm, that are easily identifiable.This means explicit costs will always have
a dollar value and involve a transfer of money, e.g. paying employees. With this
said, these particular costs can easily be identified under the expenses of a
firm's income statement and balance sheet 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 Rs.15,000 on office supplies, then
the explicit costs for the individual equates to the total expenses for the office
supplies of Rs.15,000
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.

2. IMPLICIT COSTS

Implicit costs (also referred to as implied, imputed or notional costs) are the
opportunity costs of utilising resources owned by the firm that could be used for
other purposes. These costs are often hidden to the naked eye and are not made
known. Unlike explicit costs, implicit opportunity costs correspond to intangibles.
Hence, they cannot be clearly identified, defined or reported. This means that they
are costs that have already occurred within a project, without exchanging cash.
This could include a small business owner not taking any salary in the beginning of
their tenure as a way for the business to be more profitable. As implicit costs are
the result of assets, they are also not recorded for the use of accounting purposes
because they do not represent any monetary losses or gains. 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 labour
Infrastructure
Time spent: also involves considering other valuable activities that could have
been undertaken in order to maximize the return on time invested

Scenarios are as follows:

If a person leaves work for an hour to spend $200 on office supplies, and has an
hourly rate of $25, then the implicit costs for the individual equates to the $25
that he/she could have earned instead.
If a printer of a company malfunctions, the implicit cost equates to the total
production time that could have been utilized if the machine did not break down.

5. HOW TO CALCULATE OPPORTUNITY COST

Formula:

Opportunity Cost=Return on Next Best Alternative−Return on Chosen Option

"in simple words"
Opportunity Cost=Return of investment from the Next Best Alternative−Return of
investment from the Chosen Option

Example:
Option A: Invest in stocks with a potential return of $2,000.
Option B: Start a business with a potential return of $3,500.
If you choose to start the business, the opportunity cost of that choice is the
$2,000 you could have earned from investing in stocks.

By systematically evaluating the value of your choices, you can make more informed
decisions.

#OPPORTUNIY COST AS AN ECONOMICAL TOOL

6. BENEFITS AND ADVANTAGES THAT

MAKE OPPORTUNITY COST AN ECONOMIC TOOL

1. How does Opportunity cost Benefit the Government?

Opportunity cost benefits the government by assisting them in using resources

wisely. The government handles confidential data and other things and must ensure
they are making the best decisions for the nation. By considering the opportunity
cost of resources used to produce goods supplied through the public sector. If the
government did not use these resources, then they could be used by people and firms
in the private sector. However, the government should be aware of where resources
are going.

2. Opportunity cost can benefit a business by helping it:

Make informed decisions:

By understanding the potential trade-offs, businesses can choose the option that
best aligns with their goals.
Optimize resources:
Businesses can allocate their limited resources, such as time, money, and
manpower, to maximize their impact.
Reduce risk:
Businesses can anticipate potential downsides and adjust to mitigate them.
Understand the impact of decisions:
Businesses can understand how each decision will affect profitability.

ADVANTAGES OF OPPORTUNITY COST.

1. Assists in Making Better Decisions

You can consider the possibility that you are giving up something when selecting
options. If you go to a grocery store seeking meat and cheese but only have money
for one, you have to weigh the opportunity cost of what not to buy. When you
acknowledge this, you can maximize resources and make better decisions.

2. Determine a Relatively Profitable Opportunity

Another benefit is comparing the relative prices and benefits of each alternative.
Compare the total value of each option and decide which offers the best value for
your money. Suppose a business with an equipment budget of $100,000 buys ten pieces
of equipment A at $10,000 or 20 pieces of Equipment B at $5,000. In that case, you
could purchase some of A and B, but relative pricing means comparing the value to
you of 10 pieces of A versus 20 pieces of B.

3. Avoid Humiliation during Project Implementation

There are various benefits and consequences relating to opportunity cost. It is
best to ensure you have all or most of the information you need to make proper
decisions. Depending on your choice, you may reap more losses than gains. To avoid
humiliation during project implementation, always thoroughly weigh the pros and
cons of each alternative.

CERTAIN DRAWBACKS OF OPPORTUNITY COST.

1. Time-Consuming
Opportunity cost takes time to compute and consider. You can make better decisions
by pondering opportunity costs, but managers have limited time to compare options
and make business decisions sometimes. Similar to how customers going to grocery
stores with lists and contemplating the potential opportunity costs of every item
is draining. Sometimes you have to make instinctive decisions and evaluate results
later.

2. Lack of Accounting
Though useful in decision making, the biggest drawback of opportunity cost is that
it is not accounted for by company accounts. Opportunity costs often relate to
future events, notes the Encyclopedia of Business, which makes it very hard to
quantify. This is especially true when the opportunity cost is of non-monetary
benefit. Companies should consider evaluating projected results for forgone
opportunities against actual results for selected options. This is not to generate
bad feelings, but to learn how to choose a better opportunity the next time.
3. Alternatives are not clearly known
The foregone opportunities are often not ascertainable. This also poses a serious
limitation of the concept.

7. APPLICATIONS OF OPPORTUNITY COST

1. Determining Factor Prices:

The factors for production needs a price equal to or graeter than what they command
for alternative uses.If the factor of price is less than the factor's opportunity
cost, then the said factor moves to the better paying-alternative.

2. Determining Economic Rent:

Economic rent refers to the extra earnings that factors of production receive over
and above what is necessary to keep them in their current use. Opportunity cost
plays a crucial role here. For example, if land can be used to grow either wheat or
corn, the economic rent of the land is determined by the higher value crop. The
opportunity cost of not using the land for the most profitable crop helps determine
the economic rent associated with that land.

Many modern economists use this concept for determining economic rent as per them.
Economic rent = The factor's actual earning - its opportuning cost or transfer
earning.

3. Consumption Pattern Decisions:

Consumers face opportunity costs when deciding how to allocate their budgets across
various goods and services. For instance, if a consumer chooses to spend money on a
luxury item, the opportunity cost is what they could have purchased instead, such
as groceries or savings. Understanding these costs influences consumption patterns,
leading consumers to make choices that maximize their satisfaction based on their
preferences and budget constraints.

4. Production Plan Decisions:

let's say that a producer has fixed resources and technology,if he/she wants to
produce a greater amount of one commodity,then he/she must sacrifice the quantity
of another commodity
therefore he/she uses this concept to make decisions about his/her production plan.

5. Discussions About National Priorities:

Every country has certain resources as its command and needs to plan the production
of a wide range of commodities.this decision depens on the national priorities
which are based on opportunity cost.

8. USES OF OPPORTNITY COST IN MAJOR PLACES

1. In Economic profit versus accounting profit

real life uses of opportunity cost in economic profit vs accounting profit

The main objective of accounting profits is to give an account of a company's

fiscal performance, typically reported on in quarters and annually. As such,
accounting principles focus on tangible and measurable factors associated with
operating a business such as wages and rent, and thus, do not "infer anything about
relative economic profitability". Opportunity costs are not considered in
accounting profits as they have no purpose in this regard.

The purpose of calculating economic profits (and thus, opportunity costs) is to aid
in better business DECISION-MAKING through the inclusion of opportunity costs. In
this way, a business can evaluate whether its decision and the allocation of its
resources is cost-effective or not and whether resources should be reallocated.

Economic profit does not indicate whether or not a business decision will make
money. It signifies if it is prudent to undertake a specific decision against the
opportunity of undertaking a different decision. As shown in the simplified example
in the image, choosing to start a business would provide $10,000 in terms of
accounting profits. However, the decision to start a business would provide −
$30,000 in terms of economic profits, indicating that the decision to start a
business may not be prudent as the opportunity costs outweigh the profit from
starting a business. In this case, where the revenue is not enough to cover the
opportunity costs, the chosen option may not be the best course of action.[16] When
economic profit is zero, all the explicit and implicit costs (opportunity costs)
are covered by the total revenue and there is no incentive for reallocation of the
resources. This condition is known as normal profit.

Several performance measures of economic profit have been derived to further

improve business decision-making such as risk-adjusted return on capital (RAROC)
and economic value added (EVA), which directly include a quantified opportunity
cost to aid businesses in risk management and optimal allocation of resources.
Opportunity cost, as such, is an economic concept in economic theory which is used
to maximise value through better decision-making.

In accounting, collecting, processing, and reporting information on activities and

events that occur within an organization is referred to as the accounting cycle. To
encourage decision-makers to efficiently allocate the resources they have (or those
who have trusted them), this information is being shared with them.As a result, the
role of accounting has evolved in tandem with the rise of economic activity and the
increasing complexity of economic structure. Accounting is not only the gathering
and calculation of data that impacts a choice, but it also delves deeply into the
decision-making activities of businesses through the measurement and computation of
such data. In accounting, it is common practice to refer to the opportunity cost of
a decision (option) as a cost. The discounted cash flow method has surpassed all
others as the primary method of making investment decisions, and opportunity cost
has surpassed all others as an essential metric of cash outflow in making
investment decisions. For various reasons, the opportunity cost is critical in this
form of estimation.

First and foremost, the discounted rate applied in DCF analysis is influenced by an
opportunity cost, which impacts project selection and the choice of a discounting
rate. Using the firm's original assets in the investment means there is no need for
the enterprise to utilize funds to purchase the assets, so there is no cash
outflow. However, the cost of the assets must be included in the cash outflow at
the current market price. Even though the asset does not result in a cash outflow,
it can be sold or leased in the market to generate income and be employed in the
project's cash flow. The money earned in the market represents the opportunity cost
of the asset utilized in the business venture. As a result, opportunity costs must
be incorporated into project planning to avoid erroneous project evaluations. Only
those costs directly relevant to the project will be considered in making the
investment choice, and all other costs will be excluded from consideration. Modern
accounting also incorporates the concept of opportunity cost into the determination
of capital costs and capital structure of businesses, which must compute the cost
of capital invested by the owner as a function of the ratio of human capital. In
addition, opportunity costs are employed to determine to price for asset transfers
between industries.

(DOWNLOAD THE IMAGE FROM WIKIPEDIA)

2. In COMPARATIVE ADVANTAGE VERSUS ABSOLUTE ADVANTAGE

real life uses of opportunity cost in comparative advantage vs absolute advantage

When a nation, organisation or individual can produce a product or service at

a relatively lower opportunity cost compared to its competitors, it is said to have
a comparative advantage. In other words, a country has comparative advantage if it
gives up less of a resource to make the same number of products as the other
country that has to give up more.

Using the simple example in the image, to make 100 tonnes of tea, Country A has to
give up the production of 20 tonnes of wool which means for every 1 tonne of tea
produced, 0.2 tonnes of wool has to be forgone. Meanwhile, to make 30 tonnes of
tea, Country B needs to sacrifice the production of 100 tonnes of wool, so for each
tonne of tea, 3.3 tonnes of wool is forgone. In this case, Country A has a
comparative advantage over Country B for the production of tea because it has a
lower opportunity cost. On the other hand, to make 1 tonne of wool, Country A has
to give up 5 tonnes of tea, while Country B would need to give up 0.3 tonnes of
tea, so Country B has a comparative advantage over the production of wool.

Absolute advantage on the other hand refers to how efficiently a party can use its
resources to produce goods and services compared to others, regardless of its
opportunity costs. For example, if Country A can produce 1 tonne of wool using less
manpower compared to Country B, then it is more efficient and has an absolute
advantage over wool production, even if it does not have a comparative advantage
because it has a higher opportunity cost (5 tonnes of tea).
Absolute advantage refers to how efficiently resources are used whereas comparative
advantage refers to how little is sacrificed in terms of opportunity cost. When a
country produces what it has the comparative advantage of, even if it does not have
an absolute advantage, and trades for those products it does not have a comparative
advantage over, it maximises its output since the opportunity cost of its
production is lower than its competitors. By focusing on specialising this way, it
also maximises its level of consumption.

(DOWNLOAD THE IMAGE FROM WIKIPEDIA)

3. In GOVERNMENTAL LEVEL

Similar to the way people make decisions, governments frequently have to take
opportunity cost into account when passing legislation. The potential cost at the
government level is fairly evident when we look at, for instance, government
spending on war. Assume that entering a war would cost the government $840 billion.
They are thereby prevented from using $840 billion to fund healthcare, education,
or tax cuts or to diminish by that sum any budget deficit. In regard to this
situation, the explicit costs are the wages and materials needed to fund soldiers
and required equipment whilst an implicit cost would be the time that otherwise
employed personnel will be engaged in war.

Another example of opportunity cost at government level is the effects of the

Covid-19 pandemic. Governmental responses to the COVID-19 epidemic have resulted in
considerable economic and social consequences, both implicit and apparent. Explicit
costs are the expenses that the government incurred directly as a result of the
pandemic which included $4.5 billion dollars on medical bills, vaccine distribution
of over $17 billion dollars, and economic stimulus plans that cost $189 billion
dollars. These costs, which are often simpler to measure, resulted in greater
public debt, decreased tax income, and increased expenditure by the government. The
opportunity costs associated with the epidemic, including lost productivity, slower
economic growth, and weakened social cohesiveness, are known as implicit costs.
Even while these costs might be more challenging to estimate, they are nevertheless
crucial to comprehending the entire scope of the pandemic's effects. For instance,
the implementation of lockdowns and other limitations to stop the spread of the
virus resulted in a $158 billion dollar loss due to decreased economic activity,
job losses, and a rise in mental health issues.

(DOWNLOAD THE IMAGE FROM WIKIPEDIA)

-REAL LIFE EXAMPLE OF GOVERNMENTAL LEVEL

The impact of the Covid-19 pandemic that broke out in recent years on economic
operations is unavoidable, the economic risks are not symmetrical, and the impact
of Covid-19 is distributed differently in the global economy. Some industries have
benefited from the pandemic, while others have almost gone bankrupt. One of the
sectors most impacted by the COVID-19 pandemic is the public and private health
system. Opportunity cost is the concept of ensuring efficient use of scarce
resources, a concept that is central to health economics. The massive increase in
the need for intensive care has largely limited and exacerbated the department's
ability to address routine health problems. The sector must consider opportunity
costs in decisions related to the allocation of scarce resources, premised on
improving the health of the population.

However, the opportunity cost of implementing policies to the sector has limited
impact in the health sector. Patients with severe symptoms of COVID-19 require
close monitoring in the ICU and in therapeutic ventilator support, which is key to
treating the disease.[27] In this case, scarce resources include bed days,
ventilation time, and therapeutic equipment. Temporary excess demand for hospital
beds from patients exceeds the number of bed days provided by the health system.
The increased demand for days in bed is due to the fact that infected hospitalized
patients stay in bed longer, shifting the demand curve to the right (see curve D2
in Graph1.11).[clarification needed][25] The number of bed days provided by the
health system may be temporarily reduced as there may be a shortage of beds due to
the widespread spread of the virus. If this situation becomes unmanageable, supply
decreases and the supply curve shifts to the left (curve S2 in Graph1.11).
[clarification needed][25] A perfect competition model can be used to express the
concept of opportunity cost in the health sector.[28] In perfect competition,
market equilibrium is understood as the point where supply and demand are exactly
the same (points P and Q in Graph1.11).[clarification needed][25] The balance is
Pareto optimal equals marginal opportunity cost. Medical allocation may result in
some people being better off and others worse off. At this point, it is assumed
that the market has produced the maximum outcome associated with the Pareto partial
order.[25] As a result, the opportunity cost increases when other patients cannot
be admitted to the ICU due to a shortage of beds.

(GRAPH 11.1 INDICAYTES TO A GRAPH IMAGE DOWNLOAD IT FROM WIKIPEDIA)*

9. OPPORTUNITY COST GRAPH

(paste a photo of the graph with marking which is uncomplete in the picture)
1. opportunity cost in wheat vs corn production

The graph illustrates opportunity cost using wheat and corn production as two
goods. Each point along the curve shows the maximum possible output of wheat and
corn given limited resources. The opportunity cost is the amount of one good that
must be sacrificed to produce more of the other.

For example, at the point where 100 units of wheat are produced, 0 units of corn
are produced. As we move down the curve, producing 20 units of corn requires
sacrificing 20 units of wheat. Similarly, producing 40 units of corn results in a
reduction of wheat production by another 20 units.

This trade-off highlights the concept of opportunity cost: to produce more corn, a
country or producer must give up a certain amount of wheat, and vice versa. The
curve’s straight shape indicates constant opportunity costs between wheat and corn,
meaning the rate of trade-off between them remains the same at each point.

This graph represents the efficient allocation of resources, where producing one
good comes at the cost of producing less of the other.

2. opportunity cost using the ppf or ppc

(paste aphoto of o.c using ppc)

The graph above illustrates opportunity cost using the Production Possibility
Frontier (PPF). The PPF represents the trade-offs between producing two goods, such
as wheat (Good A) and cloth (Good B). The curve shows the maximum possible output
combinations given fixed resources.

Opportunity cost is the value of the next best alternative foregone. In this case,
moving from one point to another along the curve shows how producing more of one
good leads to producing less of the other. For example, increasing wheat production
(moving right along the x-axis) requires sacrificing cloth production (moving down
the y-axis), as shown by the gray lines. This trade-off reflects the opportunity
cost of shifting resources between goods.

The curve is concave due to the law of increasing opportunity costs, meaning that
as more of one good is produced, the opportunity cost of producing it increases.

SOME REAL LIFE

SITUATION REGARDING OPPORTUNITY COST

10.
REAL LIFE SITUATIONS OF OPPORTUNITY COST

=Opportunity cost is a fundamental economic tool that represents the value of the
next best alternative foregone when making a decision. It emphasizes the trade-offs
involved in resource allocation, guiding individuals and organizations in
evaluating choices based on potential benefits. By quantifying what is sacrificed,
opportunity cost encourages more informed decision-making, promoting efficient use
of limited resources. This concept helps to analyze costs not just in monetary
terms but also in terms of time, satisfaction, and other non-material factors.
Understanding opportunity cost allows for a clearer assessment of potential
outcomes and fosters strategic planning, ultimately contributing to better economic
efficiency and optimization in various sectors. (WRITE IT OR NOT)**
# taking real life situations

=(1st situation) Government Policy Choices

Infrastructure Spending vs. Education Funding:

Situation: A government has made a budget and must decide between investing in new
infrastructure projects (roads, bridges) or increasing funding for education
(schools, scholarships).

Opportunity Cost: If the government chooses to invest in infrastructure, the

opportunity cost is the potential improvement in educational outcomes of great
minds,quality education and better employment and that could have resulted from
educational funding. Alternatively, if they prioritize education funding, the
opportunity cost includes the long-term economic benefits of improved
infrastructure, better transport system and reduced conflicts of crowding in
public.

Outcome: After analysis of economic reports, the government opts for education
funding, believing that a well-educated workforce will yield long-term benefits for
the economy. As a result, they experience a boost in literacy rates and employment

(PASTE THE PHOTO AVAILABLE)*

=(2nd situation) Investment Decisions by businesses'

SITUATION: A large tech company has $1 billion to invest in either developing a new
product (let's say a smart home device) or acquiring an existing startup company
that has developed advanced AI technology.

OPPORTUNITY COST: If the company chooses to invest in the new product, the
opportunity cost is the potential benefits and innovations that could have arisen
from acquiring the startup, such as enhanced AI capabilities that could be used
into future products. OR, if they acquire the startup, they miss out on the revenue
and market share that could have been gained from the new product.

CONCLUSION/OUTCOME: The company analyzes market trends, and long-term growth

strategies to make the decision. After thorough analysis, they choose to acquire
the startup, leading to significant advancements in their product line and
increased market competitiveness.

(PASTE THE PHOTO AVAILABLE)**

=(3rd situation) Advertising Spending Decisions

traditional marketing vs. Digital Marketing:

Situation: A large consumer goods company(food beverage or a cosmetic company)has a

marketing budget of $10 million and must decide whether to allocate it to a
traditional advertising campaign (TV, print) or invest in digital marketing
strategies (social media, influencer partnerships).

Opportunity Cost: If the company chooses traditional advertising, the opportunity

cost includes the potential reach and engagement of digital marketing, which may
resonate more with younger consumers. On the other hand, if they invest in digital
marketing, they might miss out on the broader audience that traditional media can
capture through more users through TVs and prints.

Outcome: The company opts for digital marketing, leading to higher engagement rates
and a significant increase in online sales and this decision also attracts a
younger demographic, leading to long-term customer loyalty

(PASTE THE PHOTO AVAILABLE)**