Conventionally, human wants far exceed the available resources to satisfy them. Resources are always scarce in an economy and in order to satisfy human needs, it becomes imperative to make choices concerning which needs are to be satisfies first and the one’s to be deferred or forgone.
This brings in the concept of opportunity cost to show the value of the needs that need to be satisfied first and those that need to be postponed to a further date. This study will analyze the concept of opportunity cost and how individual consumers, firms, and governments utilize it to allocate scarce resources in the economy.
By definition, opportunity cost is simply the cost of foregone alternatives. It is the cost of the best alternative, which has been sacrificed in order to spend the available resources on a certain need.
Individual consumers, firms and governments use this concept to ensure that the available resources are used efficiently. It measures the cost of what has been foregone in financial or monetary terms. According to Frederick, Novemsky, Wang, Dhar and Nowlis, consumers always face the issue of opportunity cost when making purchasing decision (553).
For example, a student may be in need of two textbooks; business and economics text book which cost $20 each yet his/her parent gives him only $ 20 to buy the textbooks. Given this scenario, the students cannot afford to buy the two textbooks simultaneously since the amount of money s/he has can only purchase one textbook. The student therefore has to make a prioritized choice on which textbook to buy first and which one to defer to a future date.
S/he has to apply the concept of scarcity and choice since s/he has more than one need to satisfy with just a few resources ($20). If s/he chooses to buy a business textbook, the opportunity cost will be economics textbook, which s/he will do without for the time being. If s/he happens to buy economic textbook, the opportunity cost will be business textbook that s/he has to sacrifice in order to buy the economics textbook.
Therefore, the student has no option other than to forego one of his/her needs in order to satisfy the other. The concept of opportunity cost also applies in government activities where government is faced with so many public needs yet the available resources to satisfy the needs are limited. For instance, a government may need to finance free university education and at the same to provide cheap and quality health care services.
The government is required to finance these two public needs yet the funds to meet the two expenses simultaneously are not available. The government is therefore required to postpone one of the needs in order to finance the other. Thus, opportunity cost will be the cost of the public needs that has to be postponed in order to satisfy the other. According to Devadoss and Wongun, firms also have limited factors of production, which need to be allocated efficiently to maximize the profit (729).
From the above analyses, the concept of opportunity cost is very important when individual consumers, firms, and governments are making decision on how to allocate scarce resources at their disposal in order to fulfill their endless needs (Victoravich 85). Since production resources do not increase with increase in the number of needs that need to be satisfied, increased spending in one area means decreased spending in another area. This allocation of limited resources is well illustrated by production possibility curve that shows how limited resources are allocated to varying needs in the economy.
Production possibility curve (PPC)
Production possibility curve is a curve or a graph that shows how limited factors of production can be allocated between two commodities. The curve illustrates efficient production level of two commodities using a fixed factor of production. For example, governments can use PPC curve to know the most efficient way to allocate limited inputs (capital and labor) in the production of two types of commodities like maize and motor vehicles.
PPC will show what will happen to the other commodity if the government increases production of one commodity (Dalal 958). For instance, if the government increases production of motor vehicle, the PPC will show what will happen to the production maize. Therefore, PPC will help the government to know the most efficient level of production.
The concept of opportunity cost is therefore very important while making microeconomic policies. Economic resources are always scarce and human needs are ever increasing such that, individual consumers, firms, and governments have no option but to make choices on how to allocate the available limited resources more efficiently.
Policy makers have to sacrifice or forego some needs to fulfill the most pressing ones. Governments have to consider and prioritize all its public expenditures in order to ensure that the scarce resources are allocated in the most maximizing way to the economy. The same concept will also apply to all firms that need to allocate inputs in the most efficient way in order to maximize profits.
Dalal, Ardeshir. “The Production Possibility Frontier as a Maximum Value Function: Concavity and Non-increasing Returns to Scale.” Review of International Economics 14.5 (2006): 958-967.
Devadoss, Stephen, and Wongun, Song. “Factor Market Oligopsony and the Production Possibility Frontier.” Review of International Economics 11. 4 (2003): 729-744.
Frederick, Shane, Novemsky, Nathan, Wang, Jing, Dhar, Ravi and Nowlis, Stephen. “Opportunity Cost Neglect.” Journal of Consumer Research 36.4 (2009): 553-561.
Victoravich, Lisa Marie. “When Do Opportunity Costs Count? The Impact of Vagueness, Project Completion Stage, and Management Accounting.” Behavioral Research in Accounting, 22.1 (2010): 85-108.