Information AboutAlternative Cost |
| CATEGORIES ABOUT OPPORTUNITY COST | |
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Opportunity cost need not be assessed in monetary terms, but rather can be assessed in terms of ''anything'' that is of value to the person or persons doing the assessing. The consideration of opportunity costs is one of the key differences between the concepts of ''economic cost'' and '' Accounting Cost ''. Assessing opportunity costs is fundamental to assessing the ''true cost'' of any course of action. In the case where there is no explicit accounting or monetary cost ( Price ) attached to a course of action, ignoring opportunity costs may produce the illusion that its benefits cost nothing at all. The unseen opportunity costs then become the ''hidden costs'' of that course of action. Note that opportunity cost is not the ''sum'' of the available alternatives, but rather of benefit of the best alternative of them. The opportunity cost of the city's decision to build the hospital on its vacant land is the loss of the land for a sporting center, ''or'' the inability to use the land for a parking lot, ''or'' the money that could have been made from selling the land, ''or'' the loss of any of the various other possible uses -- but not all of these in aggregate, because the land cannot be used for more than one of these purposes. It is important, as individuals and as Societies , to compare the opportunity costs associated with various courses of action. However, some opportunities may be difficult to compare along all relevant dimensions. AN ETERNAL TRUTH? Many see the concept of opportunity cost as one of the very few profound "eternal truths of economics," a result of the universal nature of of this economy were used to produce Gun s, let's imagine that 100,000 guns could be produced. If, instead, all the resources were used to produce Butter , let's imagine that 100,000,000 units of butter could be produced. So, should this economy's resources be used in practice to produce 50,000,000 units of butter, there will be an opportunity cost in terms of guns. Instead of the 100,000 guns the economy could have produced, it may now only be able to produce 50,000. Conversely, should this economy's resources be used in practice to produce 75,000 guns, there will be an opportunity cost in terms of butter. Instead of the 100,000,000 units of butter the economy could have produced, it may now only be able to produce 25,000,000. The Graph that depicts opportunity cost between any two given items produced by a given economy is known in economics as the Production Possibility Frontier Or Curve or "PPF." The curve describing this Frontier is not straight, but is curved outward away from the axes to reflect the higher Marginal Costs that become inevitable due to Diminishing Returns at the extremes. In the real world, the point on the graph that describes the two given items' position will always lie somewhere well within the frontier (as shown), due to the resources used by all the other goods and services that the given economy produces. However, in the imaginary economy discussed above which produces only guns and butter, the economy will be operating ''on the PPF'' (as shown by the arrow) if all resources (inputs) are fully utilized and used most appropriately ( Efficiently ). The exact combination of guns and butter produced depends on the mechanisms used to decide the allocation of resources (i.e., some combination of markets, government, tradition, and community democracy). This choice can also change. But any move upward or to the right along the PPF involves an opportunity cost. ( Scarcity means that it cannot go above or to the right of the PPF.) Any increase in gun production (a move upward) would reduce the amount of butter that can be produced, while increase in civilian production (moving to the right) would reduce the economy's ability to produce military products. On the PPF, scarcity and opportunity cost prevail. Others argue that while it is true for most individuals that most or even all choices incur some sort of opportunity cost (i.e., that something is being given up), the concept of opportunity cost does not always apply when viewed from the societal level. Suppose that the economy starts with large amounts of unused Capital equipment and Unemployed labor, as in the United States (and many other countries) in 1939. In that case, the "guns and butter" economy is ''inside'' its PPF (and not due to the production of other outputs). In this situation, it is possible to raise the employment of both capital goods and labor, ''raising'' the production of both military goods and civilian goods. In fact, the U.S. did exactly this at the onset of World War II . This is an example of "Keynesian inefficiency" being solved by increasing Aggregate Demand . More generally, if inputs are either underemployed or inappropriately employed, the production of both guns and butter can be increased by abolishing Inefficiency . In the graph, the economy moves from the "inefficient points" inside the PPF to the PPF itself. Unfortunately, we may not always be able to get this "free lunch" because Special Interest s often oppose such policies. They may impose ''institutional'' opportunity costs that represent more than natural or technological scarcity. Thus, we may see a price that represents political, economic, or Social Power rather than opportunity cost. The position of the PPF is not static. It shifts ''outward'' (upward and/or to the right) when an economy’s ability to produce increases, i.e., an increase in the aggregate number of guns and butter that can be produced. This can happen if the availability of resources (factors of production) increases, or if technology or management skills improve. Few if any of these changes are "free": for example, increasing the amount of capital goods requires sacrifice of current consumption. Thus, there is a clear opportunity cost. Some shifts may be inexpensive, however, as with some technological change. The PPF shifts ''inward'' when an economy’s ability to produce decreases, reflecting a decrease in the aggregate number of military and civilian goods that can be produced. This is possible due to some major disaster, such as hurricanes or military invasion. The PPF of the Roman Empire probably shifted inward due to the "barbarian" invasions and the end of regular law and order. SEE ALSO
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