The high importance of Opportunity Cost in Economics and Finance cannot be understated.

Opportunity cost is the cost that crops up, if you miss out on performing certain activities, that might have given you any kind of benefits or losses. If you wake up at 5:00 AM for purposeful morning activities, then your opportunity cost might be – missing out on those extra hours of sleep in your comfy bed. It can also be opting to do freelancing than a 9:00- 5:00 job or vice versa. Opportunity cost penetrates every dimension of life and various kinds of life affairs- that you choose consciously or unconsciously.

Opportunity cost by definition means, any concept that is economic and is used to increase/maximize the worth- with better decision-making. This term is usually applied in finance, accounting, and economics which simply arose from the sacrifice of surrendered opportunities which may have given support in gaining other possible opportunities.

Opportunity cost(s) are thus not just related to finances and economics. It is basically how life operates when many alternatives are thrown to live- because of this, life sacrifices some things- to get some other things. However, in some instances- choosing the best alternative might be leading a person towards a fruitful and more purposeful journey, and sometimes the sacrificed alternatives could have been the best alternative- that simply got missed.

There is also a Law on an increment of opportunity cost. This law suggests that- if businesses soar the goods production of (Goods A), then the opportunity cost to produce/manufacture an added/extra good (Good A or Good B) will fly up. Economists and Finance people need to give substantial thought to this as well.

What Can Happen Because Of Opportunity Cost?

Prospective changes take place:

The changes can be pleasant or not so pleasant, depending on what sort of substitute you choose or do not choose.

Every time we need to forgo:

If your immediate best alternative to traveling is spending time with your family- then the opportunity cost here can be forgoing the pleasure and satisfaction of having been able to spend time with your loved ones and on top of this,- the opportunity cost of traveling becomes- the hefty amount of money that would be spent during traveling. Hence, it so happens that every time there arrives a need to forgo some or the other things- if we start taking opportunity cost into consideration.

Decision-making gets affected:

Sometimes choosing a certain alternative- opportunity cost may be causing benefit to you- and sometimes you may lose out on the opportunity that might have led you to a better path. Hence, your decision-making is affected continuously.

Additional development:

Opportunity cost can flare up additional development of problems or explode an array of possibilities and solutions.

Determination of present and future:

Opportunity cost that occurs prior- allows you to ponder upon future possibilities helping you to choose the best alternatives if analyzed properly.

Fundamental to economists:

Resources are scarce in comparison to needs; one-way use of resources may create prevention in the use of resources the other way. Opportunity cost can be evaluated in terms of the effectiveness of costs and cost-utility studies.

Cost-utility studies:

If two or many involutions are made comparisons then a cost-utility study can make the opportunity cost of alternative sources being utilized- explicit/crystal clear.

Cost-effectiveness ratio:

When different involutions take place- the outcome of which is represented as Rs/outcome allows the cost occurrence of different interventions to be compared.

Inaccurate conclusions:

There might be difficulties in applying the opportunity cost concept- if opportunity cost calculation is not performed with proper analysis. This can also cause the numerical assumptions to create inaccurate conclusions.

Utilization of data:

The utilization of comprehensive and disaggregated data and the use of data science are necessary for opportunity cost finding. Hence, accounting practices usually try to avoid calculating opportunity costs because of the amount of data that it would require. The point here is that in many economic evaluations- the data of accountancy practices relating to costs are considered. So can the opportunity cost derived based on accountancy data be considered as fully reliable?

Social value and no seen market:

Usually, social works are kept as personal work and people don’t feel comfortable showing off in public. There might not be much reflection on who has performed social work, on what level, and how this has been performed. There might be a lack of data, resources, and understanding of the size and capacity of the social work market. In this case, opportunity cost may not be fully accurate- yet it can be assumptions-based.

No cash involvement case:

Sometimes opportunity costs may occur without being noticed and may not involve cash and resource transactions.

The Economics Of Opportunity Cost

How does economics define opportunity cost? The choosing of one expenditure over another causes many opportunities to pass over. These opportunities are termed opportunity costs in economics. There are always two or many alternatives! So, the next best-valued utilization of substitutes and resources creating overall value at that period- is the opportunity cost.

Isn’t opportunity cost superfluous and redundant? However, sometimes- in the case of a profession such as lawyers- superfluousness can also be a virtue. The virtue actually “reminds”- that the cost of utilization of certain resources erupts from missing out on the utilization of the same resources- though it could be utilized.

For example- In the education sector- when the government announces subsidies then also, some students need to pay a little more than what needs to be paid- due to the incurring of extra cost of resources.

Let us look at a mere example of how a student needs to pay her/his dues:

If a student needs to pay $4743 annually in college. The subsidy to the college provided by the government (assumed) is $9487. Here, it may seem that the cost is $14230 and students’ payment to college is even lower than half. Though, is it actually what it looks like? Remember- looks can be swindling!

So, what is the real cost? The real cost is $14230 plus ( + ) the chances (income, salary) that students let go, to attend college rather than going to work. This kind of opportunity cost is usually not given thought of. Hence, even the economists while performing economic theories and calculations for education sector awareness need to include opportunity cost calculation to derive the level of achievement in comparison to utilization of available resources and what could have been used (probable resources+ conditions).

Here, if the student could have earned $23718 yearly, then the real cost of college could become $14230 plus $23718, for a total of $37949. Out of this $37949 total, as tuition = $28461, and $23718 = left/foregone income or earnings. So, although the government would provide a massive subsidy, the student would be paying 75% of the overall cost.

The opportunity cost concept allows economists and finance and accountancy-related people to inspect, examine, and perform surveys of the relative monetary value of goods as well as services.

Opportunity Cost In Terms Of Finance

In simple terms, opportunity cost is also calculated as OP (Opportunity Cost)= FO (Return on best-foregone option)- CO (return on best-chosen option).

Another formula as per Coursera is Opportunity Cost = Return On Most Profitable Investment Choice (-) Return On Investment Chosen to Pursue.

Basically, In economics, accounting, and finance terms- it is very important to find out

• Explicit Costs
• Implicit Costs
• Income/earnings
• Economic profit
• Accounting profit

Here, Explicit Costs and Implicit costs are two types of Opportunity Costs.

The opportunity cost that incurs = Explicit Cost in addition to Implicit Cost ie, OP= EC+IC

The economic profit that takes place = Income/Earnings subtracting the Opportunity Cost i.e, EP=I-OP

Accounting profit that is generated= Income subtracting the Explicit Costs i.e, AP=I-EC

Here, Explicit costs are Those costs that are direct costs. For eg, costs provoked due to operations of businesses such as operating costs are explicit costs. It can be a cash transaction or a barter of resources (can be any). These kinds of costs can be known easily, as they occur during the operating procedure for businesses and are easily recognizable. For example: the salary of staff can be termed as explicit costs. It is found in the income statement and balance sheet and speaks for the cash flow of any business.

Some of the explicit costs are:

Explicit operations cost + Explicit Maintenance Costs

• Wages Costs
• Rent costs
• Overhead costs
• Materials and resources costs
• 
  

Explicit Land Costs and Infrastructure Costs

Implicit costs = Implicit costs are the opportunity cost(s) when resources are utilized although those costs could be utilized for something else or some other purposes. Even with a wide eye open- these sorts of costs cannot be seen well enough. For eg,- these costs may already happen/occur in the works performed- without getting attention. Suppose, there is a partnership agreement happening between a bank and an insurance company for insuring their employees. If, the bank would thus go ahead with the partnership without a quick survey with their employee union- then, there might occur a questionable circumstance(a cold misunderstanding) created by the conversation missing situation which may cause the contract between the insurance company and the bank to become a reason for unhappiness among employees and employee union, as the employees could not see the required sense of safety.

The current example of Banking and Financial Institutions’ Employee Unions and employees revolting against the Social Security Fund (SSF)’s rule concerning deposition of employee’s money in SSF shows that Social Security Fund Office- didn’t consider the opportunity cost that SSF would attract by asking- Bank and Financial Institutions to agree to the rules of SSF. Probably, the Social Security Fund couldn’t map out the ability of the Employee Unions of Banking and Financial Institutions. The Supreme Court spoke more on the favorable side of the Bank and Financial Institutions’ employees or employees in general. Whereas, the Bank and Financial Institutions managed to deal with the situation by predicting and analyzing the opportunity cost condition and swiftly made it in favor for them.

Having said that- the opportunity cost for the Bank and Financial Institutions can be supposed yet (undecided/assumed) long-term deprivation of added benefit of a more developed Nation- as Social Security falls in the framework of the International Labour Organization- making up ILO’s standard.

The International Labour Organization in its website has mentioned the following:

The Conventions and Recommendations that make up the ILO’s standards framework on social security are unique: “They set out minimum standards of protection to guide the development of benefit schemes and national social security systems, based on good practices from all regions of the world”

ILO has also mentioned that – “They are therefore based on the principle that there is no single model for social security and that it is for each country to develop the required protection. For this purpose, they offer a range of options and flexibility clauses for the progressive achievement of the objective of the universal coverage of the population and social risks through adequate benefit levels.”

Implicit Costs thus may include the following as well:

• Labor, Human Resources Costs
• Infrastructure Costs
• Time Costs

What Is Economics Profit?

Economics Profit is a profit that is connected with opportunity cost. This means that opportunity cost(s) are also aligned with economic profit. The reason for calculating economic profit is to support in making good decisions for organizations/businesses which lets the businesses to find out if proper assigning of resources has been done or not and to see if it requires further reshuffling of resources. Henceforth, it touches upon the cost-benefit analysis for the works of organizations.

What is Accounting Profit?

 Accounting Profit is the profit recorded in the following:

• Balance Sheets of organizations
• Organizations’ Cash Flow Statements
• Organizations’ Income statement

It is written down/recorded- having seen the usual financial/monetary value. It deals with money in any form.

It is completely measurable and not hidden and provides organizations with fiscal performance.

Is It Necessary To Determine Opportunity Cost?

To gain results that are not just quantitative and measurable and to understand the hidden and concealed costs- determining opportunity cost can help in the long-term sustainability of businesses/ organizations/companies if all the possibilities are analyzed smoothly.

• Cost-benefit as well as economic benefit can be obtained through opportunity cost analysis. It is also very important in making savings and Investment decisions. It helps to ascertain the potentiality of profits or chances of losses.
• Prioritizing becomes easy with opportunity cost analysis.
• It helps to identify the relative prices of options that you have.
• It creates an awareness about the opportunities that have been missed and/or automatically contributes to the thought process of upcoming potential/favorable opportunities.

Thus, most often, we should pursue those things that we value the most, that which is purposeful, and should have full awareness about what we are pursuing- just considering any pursuit- as our pursuit for happiness; because – there might be a lot of losses of opportunities- on the way, but our decisions and our sacrifices should always give out the best value. The opportunity cost associated with our doings should create potential benefits rather than detriment in a larger sense.