Opportunity+costs+including+implicit+costs+and+explicit+costs

Opportunity Costs, Implicit Costs and Explicit Costs
by: Lani Pence

When looking at opportunity costs, the focus is on sacrifice. Anytime choices are made, other opportunities are forfeited. Since we live in a world of scarcity, our resources can only be used for a limited number of activities or items. Choices and trade-offs must be made when it comes to the use of our resources. The opportunity cost is the benefit lost of those forfeited opportunities. Opportunity costs are not necessarily counted in monetary terms, but by the value of the alternatives to the person making the choices. Care needs to be taken when calculating opportunity costs so as to not miss costs that are essential in the calculation, nor that costs are included that should not be included. Sunk costs, costs incurred and are nonrecoverable, are not to be included in the calculation of opportunity costs since the costs are not able to be used in an alternative decision.

Opportunity costs are made up of implicit and explicit costs. Implicit costs are the costs of giving up an alternative. The explicit costs are the cost of the chosen alternative. For example, the money and time spent to go see a movie are explicit costs. However, that same time cannot be used to study for class and the money saved for another purpose. The lost opportunity of studying and saving becomes the opportunity cost of the decision.

//Opportunity Costs in the Real World// Opportunity costs are calculated in every decision we make. An easy way to help define opportunity costs is through examples. Below is a list of example decisions where opportunities and costs are valued against each other:
 * The time spent doing a fix it job yourself, or the cost of hiring the job out to someone else
 * The cost of attending graduate school, or the wages earned by taking a job right out of college
 * The joy of eating the food now, or the joy of losing weight and being more healthy later
 * The cost of purchasing new machinery and hiring additional employees to further run product, or outsourcing the additional production
 * The cost of having employees work overtime, or adding another shift to production

The first three examples are fairly easy to distinguish what the implicit and explicit costs are and what the total opportunity costs are. However, for each person, the total of each of the costs will be somewhat different as we have different value systems to weigh the choices against.

The last two examples take on more complexity as we begin to try to account for other people's value systems in our decisions and a broader base of decision making. As a company looks at purchasing new machine to futher production, many questions come into play: does the company have the floor space for the machinery, the employees to run the equipment, the demand for the product, etc. These would all be explicit costs if the machinery were purchased. The implicit costs along with the decision is the potential for non-quality product by farming it out to another company, the potential loss of customers to the outsourced company, etc. This same logic applies when looking at the overtime example, as well as many other decisions businesses make everyday. When looking at the depth of each decision, much care needs to be taken to make sure every angle has been explored and every opportunity entertained so decision makers are fully aware of the costs, both explicit and implicit, to every decision being made.

//Multiple Choice Questions//

Which of the following are used in calculating opportunity costs? a. monetary costs b. the cost of time c. preference d. all of the above

Answer: d Opportunity costs are not just in terms of monetary costs. The cost of time and preferences come into account when calculating the opportunity costs of decisions.

An implicit cost is a. the cost of giving up an alternative b. the cost of a chosen alternative c. calculated by subtracting the monetary cost of an alternative by the time invested d. none of the above

Answer: a Implicit costs are the sometimes non-monetary costs that are implied because an alternative was not chosen.

An explicit cost is a. the cost of giving up an alternative b. the cost of a chosen alternative c. calculated by subtracting the monetary cost of an alternative by the time invested d. none of the above

Answer: b When things are explicit, they are clear and apparent. Explicit costs are the known costs of the chosen alternative.

Which of the following is not a factor which should be considered in the calculation of opportunity costs? A. the cost of forfeited activities or alternatives B. purely monetary terms C. sunk costs D. embedded incentives

Answer: c Sunk costs have been spent and can no longer be considered in the opportunity costs of another decision since usually the sunk costs are not transferable to another alternative.

You won a free ticket to see an Eric Clapton concert (which has no resale value). Bob Dylan is performing on the same night and is your next-best alternative activity. Tickets to see Dylan cost $40. On any given day, you would be willing to pay up to $50 to see Dylan. Assume there are no other costs of seeing either performer. Based on this information, what is the opportunity cost of seeing Eric Clapton?

A. $0 B. $10 C. $40 D. $50

Answer: d When you go to the Clapton concert, you forgo the $50 of benefits you would have received from going to the Dylan concert. You also forgo the $40 of costs that you would have incurred by going to the Dylan concert. An avoided benefit is a cost, and an avoided cost is a benefit. Thus, the opportunity cost of seeing Clapton, the value you forgo by not going to the Dylan concert, is $10, i.e., the net benefit forgone. (Bentulan, 2006)

http://www.iwebtool.com/articles/view_10823.html Eggert, J. (1997). What is econmics? Mountain View, Calif.: Mayfield Publishing Walden, ML (2005). Smart economics: commonsense answers to 50 questions about government, taxes, business and household. Westport, Conn: Praeger Bentulan, T (2006). Street strategist: The opportunity cost. BusinessWorld, March 2, 2005, pg. S1-5