Real cost is a subjective concept. It expresses the pains and sacrifices involved in producing a commodity. However, real costs are not amenable to precise measurement. Modern economists therefore prefer the concept of opportunity cost. Sometimes, there is a discrepancy between the cost incurred by a firm and the cost incurred by the society.
For example, an oil refinery discharges its wastes in the river causing water pollution. Likewise, various types of air pollution and noise pollution are caused by various agencies engaged in production activities. Such pollutions result in tremendous health hazards, which involve cost to the society as a whole. A cost that is not borne by the firm, but is incurred by others in the society is called an external cost.
The true cost to the society must include all costs, regardless of the persons on whom its impact falls and its incidence as to who bear them. Explicit costs are those costs, which are actually paid by the firm. To put it in other words, explicit costs are paid out costs.
Explicit costs include wages and salaries, prices of raw materials, amounts paid on fuel, power, advertisement, transportation, taxes and depreciation charges. In other words, implicit costs are costs, which self-owned and self-employed resources could have earned in their best alternative uses. It refers to the highest income, which might have been received by him if he has let his labor, building and money to someone else.
These costs are frequently ignored in calculating the expenses of production. Historical cost refers to the cost of an asset, acquired in the past whereas replacement cost refers to the cost, which has to be incurred for replacing the same asset. The increment costs are the additions to costs resulting from a change in product lines, introduction of a new product, replacement of obsolete plant and machinery, etc. Sunk costs are those which cannot be altered, increased or decreased by changing the rate of output and the level of business activity.
All the past costs are considered as sunk costs because they are known and given and cannot be revised as a result of changes in market conditions. Please what is the relevant of opportunity in decision making within the scope of limited resources. Marine Biology. Electrical Engineering. Computer Science. Medical Science. Writing Tutorials. Performing Arts.
Visual Arts. Student Life. Opportunity cost can be assessed directly with cost effectiveness or cost utility studies. When two or more interventions are compared cost utility effectiveness analysis makes the opportunity cost of the alternative uses of resources explicit. Although the concept of opportunity cost is fundamental, incorrect conclusions can result from difficulties in applying the concept. Firstly, the study perspective societal, patient, etc is critical since it determines which costs and effects to include in the evaluation.
More restricted perspectives may mask the fact that costs are simply being shifted to another sector rather than being saved. Secondly, the choice of comparisons can play a crucial part in cost effectiveness analysis, affecting the measurement of opportunity cost. Ideally an intervention should be compared with all relevant interventions, including doing nothing.
Sometimes, however, the do nothing option may be unethical, such as when a new treatment is being compared with one that has been shown to be beneficial.
Partly for this reason, many studies compare particular interventions with existing practice 1 which may or may not be well defined. Failure to select an appropriate comparator may make the intervention appear more cost effective than it should, leading to wrong estimates of the opportunity cost. Thirdly, the incremental rather than average cost effectiveness ratio should be estimated. The average cost per benefit calculated by dividing the total cost of an intervention by the total benefits may be less appropriate than the incremental ratio derived by dividing the additional incremental costs by the additional incremental benefits.
Resources used in economic evaluations should be valued at opportunity cost, but doing this is difficult especially in health care, where there is no perfect market , 5 so unit costs tend to be used instead, based on the costs of the various inputs. Accounting practices do not aim to measure opportunity costs.
Even then, the allocation of overhead and fixed costs is difficult since the cause and effect relation between resources and different users is difficult to determine. Since many economic evaluations use accountancy cost data, the results should be treated with some caution. The prices of pharmaceutical products may be poor estimates of their opportunity cost because the retail price reflects the patent, the regulation of profits by governments, and the sunk research and development of both successful and unsuccessful products.
In practice, very few studies attempt to estimate the opportunity costs of drugs, relying instead on prices. Health economists disagree about the most appropriate technique for measuring the opportunity cost of time. If, for example, you spend time and money going to a movie, you cannot spend that time at home reading a book, and you can't spend the money on something else. Answer: Explanation: Opportunity cost like other basic concepts of Economics — scarcity, scale of preference and choice is important to an individual who represents the consumer or household, or firm or productive unit and the government that form the three decision making bodies in an economy.
People and organizations grow and develop to the extent that they capitalize on opportunities to do so. Opportunities are important to leaders because they're important to the people they lead. Opportunities are the venues where people can try, test, better, and even find themselves. Asked by: Dahou Weineltk business and finance job market Why opportunity cost is important in economics? Last Updated: 4th February, The concept of opportunity cost occupies an important place in economic theory.
The concept is based on the fundamental fact that factors of production are scarce and versatile. Our wants are unlimited. The means to satisfy these wants are limited, but they are capable of alternative uses. Stana Magerkord Professional. What is the best definition of opportunity cost? A benefit, profit, or value of something that must be given up to acquire or achieve something else.
Since every resource land, money, time, etc. Floria Garabote Professional. What is opportunity cost simple words? Opportunity cost.
From Wikipedia, the free encyclopedia. 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". Limber Muria Professional. What is opportunity cost in economics example? Opportunity cost is the profit lost when one alternative is selected over another. The concept is useful simply as a reminder to examine all reasonable alternatives before making a decision.
Nadin Stuerbecher Explainer. What are the types of opportunity cost? This distinction gives rise to two types of opportunity cost --explicit and implicit. Explicit Cost : This is an opportunity cost that involves a money payment and usually a market transaction. Royston El Yemlahi Explainer. What are the benefits of opportunity cost? Another important benefit of considering your opportunity cost is it allows you to compare relative prices and the benefits of each alternative.
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