Opportunity Cost

Definition: The Opportunity Cost refers to the expected returns from the second best alternative use of resources that are foregone due to the scarcity of resources such as land, labor, capital, etc. In other words, the opportunity cost is the opportunity lost due to limited resources.

Every firm or individual has limited resources, having alternative uses with varied returns. Therefore, the resource owners employ their scarce resources in the most productive use with an objective to maximize their incomes and thus, the income expected from the second best use of the resources is foregone. The opportunity cost is also called as the Alternative Cost.

The concept of opportunity cost can be further elucidated by an example given below:

Suppose, a firm has a sum of Rs 50,000 for which it has two alternative uses. It can either purchase a printing machine or photocopy machine both having the productive life of 7 years. The annual income expected from the printing machine is Rs 15,000 and from the photocopy machine Rs 10,000. A profit-maximizing firm will exchange its money for the printing machine and will let go the expected income from the photocopy machine. Thus, the opportunity cost of the income from the printing machine is the annual income expected from the photocopy machine, i.e. Rs 15,000.

The opportunity cost is not entered into the books of accounts rather is taken into the consideration for taking the business decisions, computing the cash outlays and calculating the expected profit or loss of the firm.

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