A key type of cost that is often overlooked by decision-makers is opportunity costs. This cost helps you observe various alternatives. And how to use it to make decisions. So you know what you stand to benefit or lose if you make a particular decision. This article defines opportunity costs and gives key Explanations and examples.
Definition — What is Opportunity Cost?
The forgone costs by a decision-maker for choosing alternative costs. It can be defined as the cost of forgone alternatives. More to this, opportunity cost is a future cost avoided to pursue other costs and benefits.
Cost forgone. Opportunity cost is the forgone expense. The decision-maker decides to abandon or avoid these costs for a better option. The company’s management may decide to abandon the purchase of a major piece of equipment and use the money to buy shares of another company.
Let say, a company has purchased the equipment. The purchase of this equipment will lead to an 18% Return on Investment (ROI). But for some reason, the entity went ahead to buy shares of another company. The ROI of buying shares of another company is 13%. The opportunity cost here is the 18 percent ROI. The firm would have enjoyed the 18 percent ROI investing in the equipment.
Decision-maker. The decision-maker can be an individual, company, or government. An individual may want to buy a house, invest in cryptocurrency, or buy a new car. He or she must choose among the alternatives. If he chose to invest in cryptocurrency, his forgone costs are the house or car he should have bought.
A government may choose between providing stimulus checks or palatives to its citizens or buy more covid-19 vaccines to cure killed citizens. If it chooses to buy more vaccines, its cost forgone is the palatives not provided to citizens.
Alternatives. In real-life situations, there are various alternatives available funds can be utilized. It is necessary to carry out due diligence or a calculated risk on the available alternatives before making a decision.
Opportunity Cost is that cost forgone by a decision-maker. Individuals, companies, or governments make decisions from alternate courses of action regularly. Making a particular choice will lead to forgoing other alternative expenditures. No matter who is making the decision, due diligence is necessary for success.