In economics, the cost of something is expressed depending on two variables: monetary cost and opportunity cost. Monetary cost can be expressed as the explicit costs a company has to pay. In other words, explicit costs are payments the firm makes for a product.
However, which best describes an opportunity cost?
Every time we have to make a decision, every time to choose something or someone, we are always giving up something else. The principle of opportunity cost is that resources and choices are scarce and limited, so there will always be a trade off when we make choices.
What you give up to obtain an item is called your opportunity cost. The opportunity cost of an item is calculated depending on the value of your alternatives.
What Is The Concept Of Scarcity?
Scarce is the opposite to unlimited or infinite. The resource scarcity is the principle which the science of economics is based on. To explain the concept of scarcity you have to know that resources and choices are limited in our world. If you want to have something, you are also giving something up at the same time. In other words, you cannot have everything you want, but you have to choose.
When do Opportunity Costs Appear?
As I have explained before, opportunity costs exist because resources are limited and scarce. Let us use some examples to illustrate the meaning of opportunity costs:
Friday night, after a hard week at work or college, you need to choose what to do tonight. You can either stay home and watch a movie, or you can go to the cinema.
In this example, the opportunity cost of staying home is missing the experience of cinema’s dolby surround, popcorns and 3D effects. On the other hand, your opportunity cost of going to a movie is that you will have to spend $10 (you choose to spend this money).
You are about to turn 18 and you have to make one of the toughest decisions of your life: should I go to college? Why can’t I just start my own business or work for a living?
Once more, every time you have to make a decision, this will generate an opportunity cost. In this example, your opportunity cost of going to college is that you will spend a lot of money and gain none for at least 4 years. On the other hand, the opportunity cost of NOT going to college is that you may not have many job opportunities in the future and you will be missing a wonderful part of your young life.
A little clearer now?
Have you ever wonder how opportunity costs affect companies? A firm’s opportunity costs of production are equal to its alternatives’ cost. In other words, when a company chooses to produce a single product or item, they are giving up the opportunity of going in another direction.
Remember when Facebook bought Whatsapp? What else could have Facebook done with all that money? What if they had decided to invest on a different product? This was the opportunity cost of Facebook when they decided to buy Whatsapp.
Trade-Off vs Opportunity Cost
Although these two concepts might sound familiar to most people, there are key differences between them. You probably have heard the quote “for every decision you make, there is a trade-off“. Well, that’s not entirely correct.
On the one side, a trade-off refers to the exchange of things between them, assuming that we make an exchange of one thing for the other. In other words, a trade off presumes we start owning something that we decide to change for something else. On the other side, the opportunity cost is decision based, and it occurs when we are presented with multiple choices of what we want to do or have.
When we complete a trade-off, we abandon one thing to get another one. There is a clear minus one plus one situation. However, in the opportunity cost it may seem that we only get things without losing anything. This happens because we don’t have to give up anything to complete one of the decisions. The only thing we have to give up is… the opportunity of getting something else.
What is the opportunity cost of investing in capital?
Well, by definition this would mean that the opportunity cost of investing in capital is… not investing in something different than capital. Imagine you want to invest 50,000 dollars on shares of a profitable company. By doing this you would be giving up the opportunity of investing, for example, in your own business, or in a new house.
What Does Increasing Marginal Opportunity Costs Mean?
Marginal Opportunity Cost means the single increase in cost when increasing the input by one. Assuming that we’ve already made a decision to invest our time or resources into something, the marginal opportunity cost would be the increase in opportunity cost after we decide to invest one more of the resources into the same project, it could be $1, 1 hour or any other resource we’ve considered.