The opportunity costs are those values that you lose while foregoing opportunities for a particular choice. Such costs can be evaluated. However, they can’t necessarily be a digit or some monetary value. It is also not essential for them to involve some market transaction. If they include financial payments or compensations, they are categorized as explicit costs. If they can’t be interpreted into monetary compensations, they are called implicit ones.
When your foregone alternative shows the lost value into a monetary digit, the opportunity cost is explicit one. In such a situation you are paid a market transaction is made for the value of your foregone opportunity. In other words, some other person incurs the cost while paying you for the value that you have forgone.
For example, I am offered a part-time job of a manager at a local hospital. I utilize my spare time which I could have spent with my family or friends. The executive board of the hospital is paying me in cash for the value of time which I could have spent on the next best alternative. The Board incurs value of the opportunity cost.
The opportunity costs which neither involve payment of money nor market transactions are called explicit costs of the foregone opportunities. In this situation, the person who forgoes the next best alternative incurs the costs himself, without shifting them to somebody else.
For example, we decide to beautify lawns of our hospital. Instead of paying massive amounts to the professionals we request a professional to donate his services to the hospital lawns. He is spending his time with hospital lawns by foregoing his choice to spend the same on his own business. We are not paying him a single penny for his services. He is incurring the cost himself, without shifting it to the hospital.
This website was launched with a view the help the managers to make their choices with economic reasoning. We all know that the resources are scarce so we can’t allocate them to all of our needs simultaneously. We have to shortlist the alternatives and go for the best one while ignoring the value of the next best opportunity. In brief, we can divide the concept into three components:
1- Foregone alternatives
2- Highest valued
3- Pursuit of an Activity
Opportunity cost involves alternatives which you have to forgo while preferring some particular choice. Every foregone option has some value; monetary or otherwise.
For example, you are reading this article. You could have gone to the cinema to watch a good movie which could have given you satisfaction and a break from your day to day work. But you have foregone your pleasure of watching a movie to acquire knowledge of economic reasoning.
You could have a number of alternatives to decide on the allocation of your resources. In our example, instead of reading this article, you could have selected bridge with your friends or stay with your family or watch a movie. All alternatives involve some value, but all can’t be counted as opportunity cost. Your highest value may include watching a movie with your family members. The satisfaction achieved in this way would be considered a value for your choice.
It is not only a decision to forgo the highest value of the next alternative but also to allocate your resources in pursuit of a particular choice. In our present example, you are reading this article which is an activity in itself. While talking about business when you keep money in a bank for interest, you are pursuing an activity instead of investing it in the next best opportunity. When you spend your money in one business, you are again seeking an opportunity.
These costs are also considered opportunity lost. When you invest money in some business, you lose the profit which a bank could have returned you. When you are reading this article instead of watching a movie, you are missing the satisfaction that a film could have given to you.