Opportunity Cost

Opportunity Cost is a term used in economics to indicate the cost of choosing one option over others in terms of what you loose by not having chosen any of the other options. This is applicable when the choices are mutually exclusive. The cost may not be measurable.

The opportunity cost of choosing an airline over a railway is the extra price you pay for an airline ticket and that of choosing a railway over an airline is the time and the other opportunities you would loose.

When it comes to housing you have two choices, either you could rent a house or purchase one using a housing loan. The opportunity cost of purchasing a house is the amount of money (interest and the extra costs) that you would save if you took a house on rent or more profitable avenues (if any!) where you could invest that money. The opportunity cost of renting a house is your ever reducing capacity to purchase one in future. It is what you’ll pay for a similar house ten years down the line.

Opportunity cost of employing inexperienced personnel at low cost for a job is the extra cost you will have to spend training and monitoring them, reduction in the quality of work and possible re-work. The opportunity cost of employing only experienced personnel is the eventual high price one would have to pay and sustainability of the venture some years later when experienced personnel become scarce.

For a developing nation the opportunity cost of spending its capital on defense is the reduced capacity to solve basic problems like poverty, education, employment and infrastructure. Whereas the opportunity cost of spending more capital on basic problems is the reduced capacity to defend itself.

Most often the opportunity cost is not tangible. For e.g.

  • Effect of over-work on health.
  • Health expenses and misery saved by choosing to walk or ride a bicycle.
  • Increased resourcefulness by spending some time regularly on improving/diversifying one’s skills.
  • Increased product quality and happy customers achieved by spending on effective quality practices that presently appear more expensive.

When it comes to choices involving intangible value, the opportunity cost is realized mostly only in hindsight.

 

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s