Definition of Opportunity Cost - Essay Example

The opportunity cost of a commodity is the perceived cost of an alternative commodity that could otherwise be produced instead of the former item. Different perspectives however exist for the definition of opportunity cost but they revolve around the cost that can be derived from the next best alternative. Ferguson, an economist, for example, defines opportunity cost in terms of resources and as the amount of resources for producing the next best alternative, which is forgone to produce a subject commodity. This establishes the cost of the two commodities as a common measure for determining the sacrificed cost for production. Henderson offers a definition that is closer to cost measure by defining opportunity cost as the “value of the highest-valued alternative” for which resources in production could have been used (Hussain, 2010, P. 158).

Leftwich’s definition of opportunity cost as the value of the foregone options for production in which resources would have been used is also consistent with the focus on the cost of resources in the production of a commodity (Hussain, 2010). It is however important to note that opportunity cost is not the market price of an alternative commodity or the market price of materials that could have been used in the alternative. Commodities that are produced from a similar material may have a relationship between opportunity cost and market cost but this is not always the case because of the subjective nature of opportunity cost (Baumol & Blinder, 2011). Opportunity cost is, therefore, the value, and not necessarily market price, of resources used in a production, which could have been used in the production of the next best alternative production. 

Implicit opportunity cost and explicit opportunity cost

Opportunity cost can be either implicit or explicit and the existence of reward for involved sacrifice establishes the distinction. Explicit costs in opportunity costs are those costs that are incurred for payments, in monetary or otherwise terms, to stakeholders that sacrifice their resources for the production of a commodity. Examples are costs of labor and rent that an entity incurs and pays for its operations into production. The costs identify cash flow that can be quantified from cost drivers. Remunerations can for example be quantified based on several hours worked per employee or unit of production (McEachern, 2013). Implicit costs, in opportunity cost, however, define those costs that do not involve monetary transfer from the producing entity. Examples are owner’s investments in operations such as the time that a business owner spends in an entity’s operations without rewards (Tucker, 2012). Cash flow is therefore the distinction between explicit and implicit costs of opportunity cost.