In economy, opportunity cost indicates cost of thing estimated in terms of opportunities not-realized (and them advantages which could have been withdrawn from these opportunities), or the value of the best option not-carried out. Trivialement, it is the measurement of the advantages which one gives up by assigning the available resources to a given use.

As regards Management, the opportunity cost of a Investissement is the cost of the not-realization of an investment. It is measured by the awaited Rentabilité invested funds (or assignment of immobilization S with other uses, such as for example, the hiring of a ground available). This criterion is one of those used in the choices of investment. In theory, the output is at least equal to the opportunity cost.

As regards Finance it is the profitability which would have an of the same placement risks than that carried out or considered. It is used to make arbitration S between placements.

In economy (Macroeconomics), it is good to take account of the Externalité S positive and negative to establish a complete opportunity cost.

The application of the concept of opportunity cost leads to the research of the hidden costs of any economic decision. The negligence of this concept led to current economic sophisms such as that of the “broken pane” describes by Frederic Bastiat.

Opportunity cost and use of time

The bringing together is sometimes made with the use of time according to the proverb: " time it is argent". Indeed, if one remains one hour without nothing to make, it is one hour of lost, one hour when one will not work (and thus where one will not be remunerated).

This concept also caused substantial changes in our companies:

• will to go more quickly (increasingly fast Plane, realization of more than things at the same time (Portable: to telephone in the car, in public transport…)),
• the division of the labor (initiated by the Taylorism and the Fordisme).

Opportunity cost and situation of risk

In addition this concept has direction only if the comparisons between the thing carried out and the thing not carried out are two things with equal risk ! If not it is necessary to introduce the concepts of risk and Allowance for risk.

It is also necessary to take into account the fact that the external elements are not static, which can influence the satisfaction of the things (for example a car does not produce satisfaction that if there are roads, if there is not it is not used for nothing; however the roads are elements external with the car); this results in the expression " any thing being equal in addition (or Ceteris paribus for the Latinists) " , which is thus used to present a null risk (not change of the total situation in time).

Teaching examples

• First example:

Assumptions:

1. your established budget with transport is limited, the sums below thus represent a value (each euro gets some Satisfaction).
2. you live in the suburbs of a city.
3. the bus, spending same time as conveys you and going to the same destination, 1€ costs (to go).
4. While going downtown in the car, you spend gasoline 1,5€ (we could add the wear of the tires, oil, the insurance, accident risk etc).

Thus, if you go down downtown in the car, your opportunity cost will be of 0,5€ (1,5 - 1 = 0,5), that is to say 1€ to suit it return. Indeed, if you go down downtown in the bus, you will spend 0,5€ of less than with your vehicle, that is to say a profit of 0,5€, or in economic terms a null opportunity cost (because the bus is, in this example, considered as the fastest means of transport the least expensive and)

To complicate, we could modify the starting assumptions, while taking into account that the bus spends more time than your car to arrive downtown (it must stop with bus stops), but that with your car you must park yourselves downtown (and thus to find a place, which is sometimes long, and in more paying it!) etc etc

• Another example:

You in the following situation imagine: you gain a free ticket to attend a concert of Eric Clapton. You cannot resell this ticket. Bob Dylan also occurs in concert this evening and it acts - for you - better option among the other possible activities. The tickets for the concert of Bob Dylan are on sale with 40 euros. In addition, you would be always ready to pay 50 euros any evening to go to see Bob Dylan.

Question: On the basis of this information is, which the opportunity cost associated with the concert with Eric Clapton?

Answer: The opportunity cost is of 10 euros. It is about the advantage which you give up while attending the concert of Eric Clapton.

• Another example, in the Finance:

Let us suppose a rate of profit of 5% in an unspecified manufacturing sector (representative thus a certain risk). This means that on the 10 firms of this sector, the 10 have (on average) a profitability of 5% per annum for the same risk. You are an investor and you wish to place your money: 100.000 Euros. You are interested by this sector, and particularly by a company which appears more promising to you than the others (for reasons X or there). You thus choose to place in this company, but with the greatest surprise, it has a profitability only of 4%! What makes 4.000 Euros of profits. In addition to the fact that you are disappointed, the opportunity cost here is of 1% (on the capital invests, for example for 100.000€, that made 1.000€ of cost). Indeed, if you had placed in another company of the sector (with thus the same risk), you would have gained the sum of 5.000 Euros (and not only 4.000€, which represents a cost of 5.000 - 4.000 = 1.000 Euros ).

By this reasoning, we can thus explain why companies realizing of the profit (countable) delocalize, automate ourselves, reorganize, change orientation, etc in order to increase their profit (and thus to reduce the opportunity cost of their investors, which will prefer to place elsewhere if this cost is too high…).

The monetary sphere would be thus related to the real sphere (debate which animates the economists, to see the quantity theory of money).

History of the concept

The opportunity cost is associated with a famous controversy between economists of the beginning of last century, discusses opposing to the British economists disciples of Marshall and the continental economists of the current néo-Austrian:

• For the British, the cost is a technical concept, it is the expenditure necessary to produce something.
• For the Austrian , the cost results from the Demande because it is it which fixes the level of Production according to the provision to pay this cost on behalf of the purchasers. This request depending on the satisfaction withdrawn by the purchasers, it is ultimately the Utilité and not the technique which makes the cost of the things. In this context the concept of opportunity cost is a machine of war of the néo-Austrians aiming at ruining the technological concept of cost of the British. The opportunity cost is it what the purchaser in term of satisfaction gives up while agreeing to pay the opportunity cost which it chooses ultimately.

The concept of opportunity cost has direction only if “something” is fixed, or more exactly limited, in the reasoning. Let us take again the preceding example. The choice relates to two options: Clapton against Dylan. The 50 euros of “provision to be paid” correspond well to the idea of the request for Dylan. The 10 euros correspond well to the opportunity cost to go to see Clapton. The element “fixes” here, it is the serviceable time: Dylan and Clapton pass the even evening , and you cannot attend the two concerts at the same time. If Dylan had spent another evening, there would have been no opportunity cost: you would have gone to see both quite simply.

The problem major than raises this concept is then to know if there exist “fixed” things in an economy. For is the serviceable time or space (in the absence of gift of ubiquity) that is certain, but sufficient? The current opinion of the economists that the opportunity cost can find its application only in the case of “rare” resources, i.e. is limited. That led certain economists to limit the object of the economy to situations of “rare” resources (one still finds the trace of that in all the handbooks of economy), a wise fallback position, because no one does not know very well what an economic scene could resemble where there would be no limits fixed outside the economic system as for the availability of the goods.

See too

• risky Rate
• Factor of production

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