Opportunity Costs – Definition | Types | Formula | Fields of Application

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Opportunity Costs

Opportunity Costs know two different types and different fields of application. In order to understand what opportunity costs are at all, it is first necessary to define the term a little more detailed.

Definition of Opportunity Costs

Opportunity costs or sometimes also referred to as withdrawal costs, alternative costs or shadow costs are revenues or benefits that have escaped. These arise from the fact that there are no perceptions of given opportunities – that is, possibilities – with reference to the use of different resources. In the everyday language, the cost of remorse is often referred to as the cost of repentance or the cost of lost profits. This means that opportunity costs are not part of the performance and cost calculation, but rather are an economic concept with the aim of quantifying missing alternatives.

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Two Types of Opportunity Costs

In the case of the opportunity costs, one differentiates between two different types: between the input-related and the output-related opportunity costs. These are described in more detail below.

Input-related OC

These arise when the margin contribution of a good that is produced is calculated on the input factor, which includes, for example, units, working hours and tons. This is referred to as the so-called relative cover contribution. If one were to assess the opportunity costs, one does not necessarily have to rely on the contribution of the cover contributions. Rather, an assessment can also be achieved by looking at the lost customer acquisition, the lost market shares or the lost sales in relative terms. In practice, however, the evaluation is more frequent in relation to lost piece-covers, because their comparison can be made more easily and more quickly.

Output-related OC

Output-related opportunity costs are the cost or loss of cover contributions of an alternative option, which refers not to the input but rather to the output of the production process. A distinction must be made between the alternative costs and the optimal cost. While the former includes the opportunity costs, which differ from the next alternative, the latter is the optimal cost, the selected alternative option deviates from optimal use. Alternative costs can be used to compare different production programs in a company. At optimal costs, the evaluation of an alternative is only in comparison with the optimal production program. On the other hand, that the concept of opportunity costs can often be used exclusively for evaluating alternative options after decisions have already been made. This means that only an ex-post analysis is possible.

Areas of application of opportunity costs

With regard to the scope of application of opportunity costs, it is possible to differentiate between commercial and economic areas. In the field of business management, the focus is on questions about the decision with regard to additional orders, the determination of an optimal production program and the possibility of steering costs that are oriented towards opportunities. The economic sector is more likely to be based on a theory of comparative cost advantages, on the concept of the transformation curve, and on the lost benefit.

Practical examples of Opportunity Cost

Opportunity costs play an important role, for example, in the area of social and family policy – for example, the loss of income and the professional career development of a person for family and homework, which is, of course, also child-rearing. Opportunity costs of child-rearing are thus the loss of income, the loss of pension-related claims and an increased risk in relation to employment.

At the same time, the term “opportunity costs” also means the loss of a product. In this context, the opportunity costs arise if one renounces the other product in favor of the consumption of one product.

Finally, the opportunity costs with reference to the savings policy are also to be mentioned. These arise from the sum of the opportunities that have been given in order to strengthen the economy in the short term as well as the economic growth potential in the long term. This gives away potential tax revenues.

Opportunity Cost Formula

Money is on a Toyo account and is charged with 2% interest. However, a financial investment on the financial market would have yielded a 10% return. The difference is the opportunity costs. Calculation example:

Opportunity cost formula = (x * 1,1) – (x * 1.02)

In the case of an investment of x = € 1,000, the investor would have earned € 80 more on the capital market. The 80 € represents opportunity costs. In this example, it is already clear why opportunity costs do not represent actual costs according to the business definition. The investor waives 80 €, but there is no consumption of value.

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