Opportunity Cost

Opportunity Cost

Scarcity of resources is one of the more basic concepts of economics. Scarcity necessitates trade-offs, and trade-offs result in an opportunity cost. While the cost of a good or service often is thought of in monetary terms, the opportunity cost of a decision is based on what must be given up (the next best alternative) as a result of the decision. Any decision that involves a choice between two or more options has an opportunity cost.
Opportunity cost contrasts to accounting cost in that accounting costs do not consider forgone opportunities. Consider the case of an MBA student who pays $30,000 per year in tuition and fees at a private university. For a two-year MBA program, the cost of tuition and fees would be $60,000. This is the monetary cost of the education. However, when making the decision to go back to school, one should consider the opportunity cost, which includes the income that the student would have earned if the alternative decision of remaining in his or her job had been made. If the student had been earning $50,000 per year and was expecting a 10% salary increase in one year, $105,000 in salary would be foregone as a result of the decision to return to school. Adding this amount to the educational expenses results in a cost of $165,000 for the degree.
Opportunity cost is useful when evaluating the cost and benefit of choices. It often is expressed in non-monetary terms. For example, if one has time for only one elective course, taking a course in microeconomics might have the opportunity cost of a course in management. By expressing the cost of one option in terms of the foregone benefits of another, the marginal costs and marginal benefits of the options can be compared.
As another example, if a shipwrecked sailor on a desert island is capable of catching 10 fish or harvesting 5 coconuts in one day, then the opportunity cost of producing one coconut is two fish (10 fish / 5 coconuts). Note that this simple example assumes that the production possibility frontier between fish and coconuts is linear.
Relative Price
Opportunity cost is expressed in relative price, that is, the price of one choice relative to the price of another.
For example, if milk costs $4 per gallon and bread costs $2 per loaf, then the relative price of milk is 2 loaves of bread. If a consumer goes to the grocery store with only $4 and buys a gallon of milk with it, then one can say that the opportunity cost of that gallon of milk was 2 loaves of bread (assuming that bread was the next best alternative).
In many cases, the relative price provides better insight into the real cost of a good than does the monetary price.
Applications of Opportunity Cost
The concept of opportunity cost has a wide range of applications including: * Consumer choice * Production possibilities * Cost of capital * Time management * Career choice * Analysis of comparative advantage

Incremental costs : The difference in total cost between two alternatives is an incremental cost. It is synonymous to differential cost. Incremental cost arise due to change of the level of activity. The change may be due to adding of a new product; change of channels of distribution, adding capacity etc. Incremental costs are not necessary variable in nature.

Sunk Cost : Cost which do not change under given circumstances and do not play may role in decision making process are known as sunk costs. They are historical costs incurred in the past. In other worlds, these are the costs which have been incurred by a decision made in past and cannot be changed by any decision made in the future. These costs are, however, best basis of predicting future cots. Amortisation of past expenses is the clearest kind of sunk cost.
Scarcity
Scarcity is the fundamental economic problem of having seemingly unlimited human needs and wants, in a world of limited resources. It states that society has insufficient productive resources to fulfill all human wants and needs. Alternatively, scarcity implies that not all of society's goals can be pursued at the same time; trade-offs are made of one good against others. In an influential 1932 essay, Lionel Robbins defined economics as "the science which studies human behavior as a relationship between ends and scarce means which have alternative uses." [1]
In biology, scarcity can refer to the uncommonness or rarity of certain species. Such species are often protected by local, national or international law in order to prevent extinction.
Scarcity in Economics
Goods (and services) that are scarce are called economic goods (or simply goods if their scarcity is presumed). Other goods are called free goods if they are desired but in such abundance that they are not scarce, such as air and seawater. Too much of something freely available can informally be referred to as a bad, but then its absence can be classified as a good, thus, a mown lawn, clean air, etc.
Economists study (among other things) how societies perform the allocation of these resources — along with how societies often fail to attain optimality and are instead inefficient. More clearly scarcity is our infinite wants hitting up against finite resources.
For example, fruits such as strawberries are scarce on occasion because they grow only at certain times of the year. When the supply of strawberries is lower, they are scarce, or not always available. If enough people want strawberries when none are available, then the quantity demanded exceeds the quantity supplied, resulting in a shortage.
Certain goods are likely to remain inherently scarce by definition or by design; examples include land and positional goods[2] such as awards generated by honor systems, fame, and membership of elite social groups. These things are said to derive all or most of their value from their scarcity. Even in a theoretical post scarcity society, certain goods, such as desirable land and original art pieces, would most likely remain scarce. But these may be seen as examples of artificial scarcity, reflecting societal institutions - for instance, the resource cost of giving someone the title of "knight of the realm" is much less than the value that individuals attach to that title.no?
On the other hand, that ease with which some goods can be obtained or replicated (for instance, intellectual property) led to the introduction of artificial scarcity in the form of legal or physical restrictions which limit the availability of such goods.