Oppurtunity cost on economics - Essay Example

According to Varian (1999, p327): “In the expression for cost we should be sure to include all the factors of production used by the firm, valued at their market price. Usually this is pretty obvious, but in cases where the firm is owned and operated by the same individual, it is possible to forget about some of the factors.” Varian (1999, p327) went on to give the following example which will enable a better understanding of opportunity costs: “If an individual works in his own firm, then his labor is an input and it should be counted as part of the costs.

His wage rate is simply the market price of his labor – what he would be getting if he sold his labor on the open market. Similarly, if a farmer owns some land and uses it in his production, that land should be valued at its market value for purposes of computing the economic costs. We have seen that economic costs like these are often referred to as opportunity costs. The name comes from the idea that if you are using your labor, for example, in one application, you forgo the opportunity of employing it elsewhere.

Therefore, those lost wages are part of the cost of production. Similarly, with the land example: the farmer has the opportunity of renting his land to someone else, but he chooses to forgo that rental income in favor of renting it to himself. The lost rents are part of the opportunity cost of his production. The economic definition of profits requires that we value all inputs at their opportunity costs.” When firms are making profits in an industry, the industry becomes attractive to prospective investors.

The costs of firms should include all costs incurred at their market price. This market price is the opportunity cost. “After all, the cost curve is supposed to include the cost of all factors necessary to produce output, measured at their market