Theory and problems of its application. The concept of opportunity costs of production The creator of the theory of opportunity costs is

Definition 1

Opportunity costs are economic term, which denotes lost profits (in particular, income or profit) due to the choice of one of the alternative ways of using various resources and thereby abandoning other opportunities.

The amount of lost profit can be defined as the utility of the most valuable of the excluded alternatives. Note that opportunity costs are an integral part of the decision-making process.

From the point of view accounting, opportunity costs are not expenses, they are only an economic construct for analyzing lost alternatives.

von Wieser's opportunity cost theory

Note 1

The term “opportunity costs” was first introduced by the Austrian economist F. von Wieser in 1914 in his book “The Theory of Social Economy”.

Opportunity costs are expressed not only in kind (in a product whose consumption or production had to be abandoned), but also in the monetary equivalent of such an alternative. In addition, opportunity costs can be expressed in the form of lost time from the perspective of its alternative use.

The main provisions of the theory of opportunity costs:

• productive goods represent the future. Their value depends on the value of the final product;
• due to limited resources, competition arises, as well as alternative methods of their use;
• the subjective nature of production costs determines those alternative opportunities that have to be sacrificed in the process of producing any good;
• Any thing is characterized by actual utility, which represents the lost utility of other things that could have been produced using the resources spent on the production of this thing (Wieser's law).

The significance of the theory developed by von Wieser for economic science is that it was the first to describe the principles efficient production.

Calculation of opportunity costs

Note 2

When calculating opportunity costs, it is necessary to separate out non-relevant costs, which include depreciation, rent, general business expenses and some general corporate expenses. Irrelevant costs do not change, regardless of the decision option.

For example, when making a decision regarding the release of a new type of product, it is necessary to calculate the costs that the enterprise will incur in the production and sale of this new product, then this value is compared with the expected income from its sale.

On the one hand, it seems that for these purposes it is quite natural to use calculation full cost products, multiplied by planned sales volumes, to obtain the total cost of the new product. But with this approach, you can lose sight of a key circumstance: a significant share of costs is associated with those cash flows that took place even before this decision was made in the past.

Financial management focused on cash flows that are generated as a result of sales management decisions, makes it possible to calculate opportunity costs based on the amount of planned outflow cash as a result of this decision. In any case, fixed indirect costs will remain unchanged, so they should not be taken into account in the calculation of opportunity costs.

Efficiency of the investment project

When calculating the efficiency indicators of an investment project, one should take into account only the upcoming revenues and costs during the implementation of the project, including those associated with the involvement of previously formed production assets, as well as future losses caused directly by the implementation of the project (for example, from the suspension of existing production due to the organization of a new one in its place).

Previously generated resources used in a new project are valued not by the costs of their creation, but by alternative cost, which reflects the maximum amount of lost profits associated with the best possible alternative of their use.

Thus, the calculation of opportunity costs is commensurate exclusively with direct costs.

The concept of opportunity costs has firmly entered scientific circulation. It is used in courses such as microeconomics, management accounting, and methodological recommendations when determining the opportunity cost of property: “Property invested in a project for the purpose of permanent use, but created before the start of its implementation, is recommended to be taken into account in the calculation cash flows at opportunity cost."

Opportunity cost theory can help make more effective economic policy decisions and provide clues to predicting the situation in individual markets. The development of alternative economic thinking of buyers, sellers, managers, and politicians is very important in modern economic conditions.

However, despite some attention to the theory of scientists and practitioners, there is a gap between the theory of opportunity costs and the immediate needs of economic decision makers. The author of the article tries to reduce this gap. In particular, there are two main problems in applying the theory - measuring opportunity costs and alternative valuations in imperfect market conditions.

1. Choice: freedom and restrictions

An alternative approach is based on the awareness of the fact of limited financial, human, material and other resources, as well as the associated limited freedom of choice. As you know, all benefits are divided into reproducible, non-reproducible and limitedly reproducible. The costs of lost opportunities in relation to reproducible and limitedly reproducible resources (in a more or less long term, sufficient for the emergence of new resources) will be less than in relation to non-reproducible resources. In the case of such a fixed resource as time, its use in one direction means a 100% loss of the opportunity to use it in another way.

One of the restrictions on the freedom of an economic entity in choosing alternatives is its budget. We can say that the set of alternatives is dependent on the budget constraint; as this constraint changes, the number of alternatives changes. In addition, for any subject, in any project, it is possible to distinguish a non-alternative (within its limits, expenses are predetermined, rigidly specified) and an alternative (within the framework of which a choice of directions for spending funds is possible) parts of the budget. Regardless of what choice a person makes after graduating from secondary school (continuing studies at a university or working), he will spend money on paying for housing, buying food, and clothing. This non-alternative part of the costs is not included in the cost of lost opportunities.

The freedom and choice of an economic entity can expand or contract depending on changes in its budget constraint. Thus, easing the budget constraint of an enterprise through a loan or issuing shares allows it to increase the use of material and human resources in some areas (not by reducing costs in other areas), completely or partially avoiding the costs of lost opportunities.

2. Problems of measuring opportunity costs

Much has been said about the difficulties of estimating these costs. The author of one of the publications on health economics notes that modern accounting is not aimed at measuring opportunity costs in medicine, in particular, due to obstacles to establishing the cost/benefit ratio for each patient.

In some cases, opportunity costs can be determined without any problems:

• - when calculating according to the “work - leisure” model. Monetary terms provide an alternative measure of leisure time for working adults. This is the hourly rate of pay that they would receive in a paid job;
• - when assessing various areas of employment. For example, choosing a job as a doctor in government agency with a monthly salary of 1500 UAH, a specialist loses the opportunity to practice private practice with a monthly income of 4000 UAH;
• - when assessing internal costs in management accounting. For example, it is possible to assess lost wages by the owner of the enterprise and at the same time by its manager; assessment of unobtained rent the owner of the building using it for his business;
• - when assessing lost opportunities due to storing money “under the pillow”;
• - when comparing different investment projects when both costs and benefits are expressed in monetary terms. For example, a person decides whether he should invest in his higher education or not. Opportunity costs are determined here based on the explicit and implicit losses associated with obtaining higher education;
• - in calculations and assessments using indifference curves. Movement along an indifference curve, as is known, shows what alternative price economic agents give for abandoning one good (good quality) in favor of another good (quality). In other words, the propensity of an economic entity to sacrifice one good in favor of another, the marginal rate of substitution of one good for another, the degree of importance of one good in relation to another are quantified;
• - when estimating using isoquants. The latter show the level of interchangeability of production resources when producing a certain amount of products.

In some cases, the costs of lost opportunities can be more or less accurately determined only in kind. In the neoclassical concept of opportunity costs in the field of consumption and demand, the subject sacrifices one utility for the sake of another. The cost of purchasing and using a certain amount of good A is the impossibility of purchasing and using a certain amount of good B. In other words, the price of good A is expressed in good B. For example, if in order to obtain three units of good A a subject must sacrifice nine units of good B, then the price of A is relatively B will be equal to three.

Speaking about the natural measurement of lost opportunity costs, it is necessary to pay attention to the following typical example. There are 2 goods: A (guns) and B (oil), and only one factor of production X. This factor can create a unit of good A and 4 units of good B. Therefore, in order to produce a unit of good A, you need to sacrifice four units of good B, then is in terms of opportunity cost A = 4B, or B = A/4. If prices are equal to opportunity costs, then we get P A P b = 4, where R A is the price of a unit of good A, a R B - the price of a unit of good B. Thus, the lost opportunities here also come down to in kind, to a loss of utility for society. Since utilities are difficult to measure, the assessment of lost opportunities in this case is subjective in nature, based on ethical and other non-economic considerations.

In many cases, opportunity costs cannot be measured at all or are estimated very roughly due to the need to take into account huge amount losses and gains as a result of choosing one or another behavior option. Let's look at some of these cases. By choosing one strategy for operation and development, the enterprise loses the opportunity to develop in a different direction; the country chooses one direction of socio-economic development, while sacrificing another. In both cases, the alternatives available to the enterprise and the state are very difficult to compare due to their heterogeneity and the impossibility of bringing them to a common denominator. It is even more difficult to make a cost, monetary assessment of alternatives when it is necessary to take into account the impact of a particular alternative solution on social welfare.

At practical application The concept of lost opportunity costs uses an imputation procedure. The concept of “imputation”, or imputation, was one of the first to be used by the Austrian scientists K. Menger and F. Wieser. It means a procedure for linking certain actions of an economic entity with the benefits that it could have received if it had taken other actions. To carry out the imputation procedure, it is necessary to bring costs and benefits to a comparable form. If the benefit is fixed in the form of some goal, then only costs are compared. For example, you can get to work by trolleybus or minibus. In this case, when evaluating alternatives, the time and cost of commuting are compared. In other cases, with stability of costs (certain budget restrictions) benefits and results are compared.

In general theoretical terms alternative approach to the analysis of economic processes and phenomena involves placing alternatives according to the degree of their attractiveness: efficiency, profitability, quality of the result, etc. In practice, the task of assessing economic alternative costs is to reduce all costs and lost benefits to money and time, that is, to the fact that can be measured. And the imputation procedure is carried out without any special complications when the basis for comparison is money or time. For example, to measure the alternative value of time of working-age people, imputation of time from paid work to leisure time is used; or imputation of the salary that a manager could receive while working for hire, working at his enterprise.

However, imputation procedures will differ for different resources depending on whether they are currently in use or not. It is impossible to impute the time of inactivity of an unemployed person to the salary that he could receive in a paid job.

It should be noted that when comparing alternatives, in some cases not average, but incremental cost-benefit ratios should be used (additional costs are compared with additional benefits). In medicine, one type of intervention must be compared not only with other types of intervention, but also with non-intervention.

Difficulties arise when using the imputation procedure. The main obstacle is that it is not always possible to reduce to a common denominator all the losses that a subject incurs when making this or that decision.

It is believed that opportunity costs arise from not using the best available opportunity. But what may be lost is not the optimal, best opportunity, but, say, the so-called second best ( next best), third, etc. Having chosen the optimal option, we lose the opportunities associated with using non-optimal options. In each specific case, it is advisable to ask the question: should the cost of lost opportunities include one unused alternative, part of them, or all of them?

Another problem with assessing lost opportunities is its subjective nature. In some cases, ranking alternatives according to their degree of attractiveness is subjective; choice of costs and benefits (effects), which are taken into account when comparing different options for economic actions and use of resources.

Processes related to alternative assessments, as a rule, affect the interests of different economic entities. Increasing the opportunity price of a resource is beneficial to its sellers and disadvantageous to its buyers. Using a resource in one direction and not using it in another may meet the interests of one group (person) and not meet the interests of another group (person).

In addition, the decision to choose from several alternatives in some cases is made by a group of people (in economic policy, at the enterprise). Therefore, the problem arises of assessing the costs of lost opportunities for this group and for each of its members separately. The owner of a large block of shares in an enterprise can block an alternative, which, according to him, entails high opportunity costs for the enterprise as a whole, for all shareholders, but in fact - only for him. In the future, the subjective nature of lost opportunity costs may become a subject for joint research by representatives of economic, psychological and sociological sciences.

Taking into account the above and recognizing the difficulty of estimating alternative costs, we can propose an algorithm for estimating the alternative costs of one of the key economic entities - an enterprise: 1) determining the non-alternative part of the enterprise’s costs (administrative and management costs, insurance payments, etc.) and the alternative (part of the costs of wages, purchase of materials, etc.); 2) putting forward alternatives within the framework of the alternative part of the costs; 3) comparison of discounted flows of “costs and income” for each alternative, placing them according to the level of profitability, the effect obtained, etc.; 4) implementation of the imputation operation and assessment of losses when choosing a non-optimal alternative.

For example, the budget for the alternative part of expenses over 5 years is UAH 50 million, which can be spent on technical re-equipment of one of the workshops, measures to stimulate and retrain employees, advertising and other measures to stimulate sales. After assessing the discounted flows of “expenses - income” for each direction over a time period of 5 years, it turns out that technical re-equipment will bring 10 million UAH. profits, measures to stimulate and retrain employees - 3 million UAH, and measures to stimulate sales - 5 million UAH. Imputation best alternative- technical re-equipment - the other two allow us to conclude that the choice of measures to stimulate sales means a loss of 5 million UAH, and measures to stimulate and retrain employees - 7 million UAH.

3. Alternative valuations in imperfect markets

Market imperfections make alternative resource valuations difficult. In a perfect market, land, labor and other resources are given to the economic entity that finds the most profitable use for them at the moment and therefore offers the highest price for such a resource. In other words, the value of a resource in a perfect market is really determined by its use in the best alternative direction. Thus, in the urban land market in Ukraine, which is more or less close to a perfect model, it is no coincidence that this resource has recently been used for the construction of expensive housing and business real estate.

In reality, on the path of the subject capable of providing the most efficient use resource, there may be various obstacles:

• - erected by restrictive policies of monopolies, oligopolistic structures, and the state;
• -- related to the lack of information from the most effective potential user about the availability of such a resource;
• -- caused by restrictions on resource mobility.

Thus, employer A can provide best use and pay more high salary a specialist employed by employer B. However, employer A is located in another city, and employment with him is accompanied by serious moral and psychological costs. Therefore, the specialist remains to work for employer B. Thus, in an imperfect market, the resource may end up with a less efficient user and not receive the highest (possible) assessment.

There are the following resource markets: more or less close to a perfect model and imperfect ones. In addition, there are areas of the economy where the market does not function at all. Moreover, in the same sector of the economy, both those resources for which the market exists and those for which it does not exist can be used. In medicine, the latter includes the time of the patient waiting in line, the time of informal care for the patient. It should also be noted that on different markets One market imperfection stands out in sharp relief.

It cannot be said that the more perfect the market, the more realistically actual prices reflect opportunity costs, and the actual valuation is more inclined towards the alternative. It’s just that for each market for a good there is its own alternative price.

Over time, changes may occur in the nature and magnitude of market imperfections. A monopolistic market can become an oligopoly, an oligopoly can come closer to the model perfect competition. A quasi-market can be created in place of a state monopoly. As access to different alternatives changes, the costs of lost opportunities for business entities change accordingly. With the reduction of market imperfections, economic entities have new alternatives.

For an effective alternative assessment of a resource, product, or service, a market for them can be created, some market imperfections can be eliminated, and reduced. Thus, a quasi-market can be created in place of government supplies of services.

Speaking about the impact of market imperfections on the alternative assessment of a resource, a product, such assessment should be highlighted in different situations: a) during the initial assessment of alternatives for using the resource; b) when a problem arises of diverting already occupied resources from alternative uses. In the second case, when making an alternative assessment, it is necessary to take into account the costs of overcoming obstacles associated with the transition from one alternative for using a resource to another. The magnitude of these costs influences the inclusion of a particular alternative in the list of feasible and economically feasible alternatives, the magnitude of the opportunity costs and the price. The cost of transferring a resource from one area of ​​application to another indicates the degree of market perfection: markets for more flexible, mobile resources are more perfect.

On perfect markets the establishment of an alternative price based on opportunity costs occurs automatically, without the participation of external forces. If the market does not function or functions weakly, the valuation of the resource finished goods various institutions are included. As a result, it turns out that it is not the most advanced technologies, samples of goods and services that win; vacancies are filled by not the most worthy workers. In cases where alternative valuation of resources is impossible or complicated, resources are valued at actual prices.

The microeconomic category of opportunity costs can be used in making macroeconomic decisions. The problem of choice at the macro level has long attracted the attention of researchers. In almost all textbooks the curve is described production capabilities. When the economy is at one point on this curve, producing, for example, guns and butter, the opportunity cost of producing more guns is underproducing a certain amount of butter.

The opportunity costs of decision-making at the macro level are based on limited resources, primarily state budget funds. Let's take as an example an action such as financing unemployment benefits. Having spent funds on this action, society, to a certain extent, is deprived of the opportunity to: 1) subsidize enterprises that could create new jobs that could partially or completely “absorb” the unemployed; 2) provide enterprises with new orders, and therefore the opportunity to create additional jobs.

Alternative costs of investment economic growth in short term is some limitation social programs. Intensive budget support agriculture accompanied by a lost opportunity to equally intensively finance the coal industry.

It should be noted that the distribution of centralized financial resources by industry, sector of the economy is associated with the distribution of qualified labor, fuel and energy and other limited resources. Therefore, the redistribution of centralized budget funds is always accompanied by the non-receipt of these limited resources by some industries or areas of the economy. For example, when deciding to increase the army from 200 thousand to 300 thousand people, society loses not only monetary and material resources that could be used for civilian purposes, but at the same time the opportunity to use 100 thousand people in a different way is missed. productive population.

It should be noted that the reversibility (irreversibility) of macroeconomic decisions is important for making a decision on the choice of one or another direction of the country’s socio-economic development, one or another project financially supported by the state. When carrying out certain actions, the state, and with it the entire society, bears sunk costs; that is, it is no longer possible to obtain any additional benefit from the money, material and human resources spent on the action.

In other cases, macroeconomic decisions are fully or partially reversible: 1) resources used during development in one direction are then redirected for use in another without much difficulty; 2) implementation of some public projects is accompanied by positive externalities that are felt by implementers of other government projects.

Choices in macroeconomics are limited. Firstly, every state has social obligations to the population; secondly, there are obligations to support certain sectors of the economy. Without investing a certain minimum in the development of education, healthcare, and fundamental science, we largely lose them forever, or in the future, their restoration may require significant funds and time.

Thus, there is a certain non-alternative minimum, within which the use of resources cannot be an object of choice, and therefore talk about lost opportunities is inappropriate here.

It should be noted that there are varying degrees of urgency when government spends funds. Certain areas of spending funds are strictly defined (subsidies for housing and communal services, pensions), and under no circumstances can they be the object of choice. Other obligations are not so strictly fixed; their fulfillment sometimes happens to be neglected. Decisions about the urgency of government spending are largely political.

It should also be taken into account that in macroeconomics the choice is limited by dependence on the previous development of the country and its institutions. Having taken one step in economic policy, the state in some cases partially or completely loses the opportunity to take a second one.

In historical terms, the socio-economic development of a country is a chain of successive elections at certain turning points in time. The movement of the state from one turning point (node ​​of alternatives) to another is accompanied by a series of lost opportunities. The loss of one of the opportunities at some turning point could be fatal for the country. Returning to the starting point and making a different choice may require significant investment and time. For Ukraine and other post-Soviet states, we are talking about fundamental changes in socio-economic life that occurred as a result of the revolutions of 1917, and the subsequent return of countries to the optimal path of development in the 90s of the 20th century.

If the course is set for market economy, globalization, turning in the other direction can be very expensive. Choosing the wrong path for the development of a country, region, industry, state institute entails losses in GNP, output volumes, production effect, social conflicts and shocks.

But even within the framework of the country’s market orientation and its course towards economic openness, the problem of choice and lost opportunities arises. Globalization should be based, in part, on a country's comparative advantage. It can focus on existing relative advantages (cheap labor, low prices for metal, coal) or change its competitive advantages and enter sectors of the economy where non-price competition prevails.

In economic theory, the concept of utility and the concept of cost of production were opposed to each other in terms of determining the price of a commodity. Wieser set himself the task of overcoming this opposition because he believed that production costs and utility are by no means in complete opposition to each other. In the Austrian theory, the value of productive goods is determined marginal utility product that can be produced with their help. By producing one good, the producer sacrifices the opportunity to produce other goods, so production costs measure the total utility of other products that can be obtained using these productive means. Wieser's concept of costs turned out to be original, but within the framework of the ideology of the Austrian school. Its costs consist only of lost utility. In this, Wieser's theory of costs is fundamentally different from the understanding of costs among representatives of the classical school, since it does not contain any real costs of production factors, or in Marshall, and is not associated with the “hardships” of labor, as in W. S. Jevons. This approach to understanding costs allows you to directly compare them with the utility of the product, which makes them comparable for any economic entity. Wieser believed that this understanding of costs is applicable not only for a “simple economy”, but also for a “developed national economy”.

Imputation theory

This theory is actually a theory of the distribution of income from various factors of production. In other words, this theory, proposed by Wieser, tried to explain how various factors of production participate in the distribution of the final product. Wieser considered the problem of imputation important because the factors of production do not participate in the production process equally. In his opinion, for example, labor stands above the material factors involved in production, it exercises leadership, while others are only its auxiliary means, its tools, not possessing in themselves purposeful creative living force. Wieser abandoned the principle of exclusion proposed by K. Menger, when the cost of a unit of a production factor was measured by the loss of production in the event of withdrawal of this unit from the production process. Instead, Wieser proposed the principle of participation in production. This principle was supposed to help determine the contribution of each factor to the production process: each productive means can be used in various combinations with another productive means, and therefore from the changes in income due to these variations, it is possible to determine the magnitude of the impact that each of the partial causes has.

Wieser looked at discrete changes in the economy and argued that if you follow Menger's logic literally, then the sum of the income of the factors of production will be greater than the product produced itself. Menger's mistake was that he did not understand the fact that the elimination of a unit of one of the factors of production may adversely affect the productivity of the remaining factors of production. Wieser believed that changes in combinations of factors of production cannot be continuous, but must be discrete. In other words, the amount of income of the factors of production cannot be more or less than the factors involved in production; it must fully correspond to them. This statement by Wieser stood out from the framework of the marginalist approach and provoked sharp criticism from opponents. For example, Böhm-Bawerk argued that the total value of shared factors of production is less than the sum of the values ​​attributable to these factors of production. There is no contradiction in this statement, since often the whole is greater than the sum of the parts, this is the principle of synergy.

Wieser also distinguished between “general” and “specific” imputation. General imputation refers to the case where different products are produced using the same productive goods. Specific imputation is ensured through specific “production means”.

Eugen von Böhm-Bawerk(1851–1914) was born into a political family in Brunn (Moravia, now Brno in the Czech Republic). He received his education at the University of Vienna at the Faculty of Law. While studying at the university, he read K. Menger's book "The Foundation of Political Economy" and became a supporter of his theory and its active apologist. While studying at the University of Vienna, Böhm-Bawerk became friends with Friedrich von Wieser, whom he had known since his gymnasium years. After completing his studies at the university (1872), Eugen entered the service of the Austrian Ministry of Finance, where he worked until 1880, holding various positions. Simultaneously with public service, he taught political economy, first in Vienna, and then at the University of Innsbruck, where he remained until 1889, becoming a professor there in 1884. During this time, he published the first two (of three) volumes of his main scientific work entitled "Capital and Interest". At the same time, he actively defended the new economic theory Menger.

In 1889, Böhm-Bawerk was again invited to the Ministry of Finance to develop a financial reform project. He prepared a proposal for reform of the tax system, in which he proposed changing the amount of direct taxes in order to stimulate economic growth in the Austro-Hungarian Empire. His project was soon approved and enjoyed great success with the public. Then in 1895 Böhm-Bawerk took over as Minister of Finance of Cisleithania (one of the two components Austro-Hungarian Empire), in which he served two terms, a third time, remaining in this post from 1900 to 1904. As Minister of Finance, Böhm-Bawerk continuously fought for strict adherence to the gold standard monetary system and for a balanced state budget . In 1904 he resigned from civil service, when he could not counteract the sharp increase in military spending that threatened the budget. In the same year he returned to teaching, heading the department at the University of Vienna. Eugen von Böhm-Bawerk died in Kramsach (Austria-Hungary) in 1914.

Among the works written by Böhm-Bawerk, one can first of all note his fundamental work “Capital and Interest” in three volumes. The first volume is called “History and Criticism of the Theories of Interest” and was published in 1884. This volume examined such issues as the problem of interest; theories of productivity, use, moderation and exploitation; unpopular systems and labor theory. In 1886, another work by Böhm-Bawerk, “Fundamentals of the Theory of the Value of Economic Goods,” was published, which was written to occupy the position of privatdozent at the University of Vienna. In this book, the young scientist has already outlined his main ideas, developed in later works. After the publication of this book, Böhm-Bawerk's reputation as the head of the Austrian school was firmly established. True, even earlier, in 1881, Böhm-Bawerk’s first work, “Rights and Relations Considered from the Point of View of the National Economic Doctrine of Goods,” was published. The second volume of “Capital and Interest” was published under the title “Positive Theory of Capital” in 1889, where such concepts as “the nature of capital and its concept”, “category of value”, “price”, “source of interest” and “ interest rate." As B. Seligman noted, the second volume is a rather eclectic work. "The Positive Theory of Capital" is completely devoid of integrity, this book seems to differ only slightly from a collection of essays, each of which does not agree with the others." The third volume, called "Further Essays on Capital and Interest", was published in 1921, after death of the author and included 12 excursions, it was, in fact, an addition to the second volume, and also contained responses to criticism of the entire work from its opponents.

09 Feb / 2019

How to find the opportunity cost of each decision made?

How to find opportunity costs and calculate lost profits?

Opportunity costs basically include those benefits that you can no longer obtain because you took one of several possible solutions. Lost profits sounds ominous. As if you could actually make a mistake if you make the wrong choice. Every day we make small decisions that also involve various opportunity costs. Therefore, in order for you to take the most profitable solutions, it is important to understand how opportunity costs work and how to find opportunity costs. Let's find out!

What is opportunity cost?

Opportunity cost is what you give up when you choose an option. No matter what decision you make, there is always best option, which you can refuse and, accordingly, miss a more profitable opportunity.

You can never completely eliminate opportunity costs because every decision you make has a potentially profitable alternative. It's important not to dwell on the "what ifs" and "should haves." Be pragmatic and responsible every time you make a decision.

“One of the most important concepts in economics is “opportunity cost” - the idea that once you spend money on one thing, you can no longer spend it on anything else.” (Malcolm Turnbull)

Alternative possibilities consider what you cannot do as a result of each possible decision.

Alternative possibilities = return the most profitable option— return the selected option

Shortage

All our resources: time, money, efforts are not endless and can be used in various ways. You can use the time planned for acquiring a new specialization, for example, to improve your skills in your current profession.

In this situation, you will need to decide what is the most valuable opportunity to allocate your time and what will have the greatest return on your chosen investment option. You must carefully consider your decision to ensure that the benefits gained from choosing one option will be more valuable than choosing the other.

Simple Examples of Opportunity Costs

Even just deciding where you want to eat results in inevitable missed opportunities. You want to go out for dinner. You decide to go to a French restaurant instead of an Italian one. The pleasure of eating Italian food is the opportunity cost of this decision.

Although you may be satisfied with a meal in a French restaurant, even more than in an Italian one, you will still miss out on good food and a pleasant experience.

Opportunity costs may also apply to your daily purchases. Do you want to connect cable television and buy new book. But you don't have the money for both options. You choose a book. The pleasure of watching cable TV is an alternative option.

Examples in investing

Of course, there are situations where the opportunity cost of a decision is much higher than choosing between a steak or a burger. The choice of investment vehicle is one area where opportunity costs need to be considered more carefully.

Every time you invest your money, you should expect certain opportunity costs. Even the most experienced traders and industry professionals financial investments were disappointed by stocks that plummeted despite initially favorable forecasts. Other times, stocks can skyrocket even when no one is predicting them to do well.

Factoring in the opportunity costs of all investment options will allow you to make informed decisions about where to invest your money.

Do you invest the extra $5,000 in Facebook after a bit of a flop, or do you invest it in Kodak?

The real cost depends not only on the difference in returns you'll get from a particular set of stocks, but also on the time you spend waiting for your investment to pay off. For example, you have $10,000 worth of shares that you can sell now for $15,000, but if you delay selling for three months, the value of the shares is expected to increase. But you decided to sell now.

The alternative opportunity would be the difference between the $15,000 you received from selling early and the price you would have sold the stock for three months later. When investing, time is money!

Perhaps you could do more more money, perhaps - you would lose money.

Opportunity costs are not always obvious.

Investment decisions don't always depend on how much money you could make or lose. In the above example, it is quite possible that it is more profitable with financial point The view is to decide to make a profit of $5,000, rather than expecting an increase in profit in three months.

Perhaps you could use that $5,000 to pay off a loan or debt early to avoid paying high interest. Perhaps you could use that $5,000 to invest in another promising stock that is expected to rise in value quickly.

Hidden and obvious costs

When considering opportunity costs, we must consider two types of costs: hidden and explicit.

Consider studying at a university. The obvious costs of such a decision are the costs of things like tuition, room and board, books, etc.

The time required to attend classes also requires financial costs. This is a hidden cost. From the point of view of having to pay, such expenses do not cost us anything, so they are not so easy to calculate. Another hidden cost is the money that is lost due to being overworked during training.

Many people forget about the hidden costs associated with the decisions they make and instead focus on the obvious opportunity costs. Unfortunately, this thinking fails to take into account some important consequences of financial decisions.

For example, the opportunity to take a refresher course. This may cost you a few hundred dollars, but it can also give you the opportunity to improve your career.

In this case, you could earn tens or even hundreds of thousands of dollars more than if you went the other route. In this example, the explicit cost is relatively minor, but the implicit cost is significant.

Do nothing

Doing nothing is also an option. Sometimes we are so overwhelmed with information that we can't make a decision, so we just stand still. This will lead to dire consequences. We all know how valuable time is when it comes to investing. Inaction has an alternative possibility. Late investment leads to losses.

Unfortunately, people who are faced with complex and multifaceted investment decisions often choose to do nothing. By taking no action, they can avoid the risks entirely, even though they lose the benefits of the investment.

Careful consideration of options and risks is important. However, don't get so carried away with your research that you keep putting off making decisions.

In the investing world, time is of the essence, and hesitation can cause you to miss out on good opportunities.

Three questions

The number of alternative possibilities is almost limitless. But you don't need to go into that much detail. It is enough to understand how to find opportunity costs in three areas:

1. Money

What else could you do with this money? Perhaps you could use your funds for training or education rather than investments to maximize your long-term financial benefits.

2. Time

What else could you do with this time? In some cases, your time is more valuable than your financial capital. Make sure you understand how you will have to spend your time when you make a personal or professional decision.

3. Effort

Where else could you spend your efforts? If a certain stock can make you significant profits, but it requires a huge amount of effort to monitor trends and patterns, it may not be worth it in the long run. You may decide that your energy is better spent on your current professional endeavors.

Answering these three questions will answer the question of how to find opportunity costs to make the best decision. Start putting your knowledge of risk mitigation into practice

Opportunity cost, opportunity cost, or opportunity cost (English: Opportunity cost(s)) is an economic term denoting lost benefit (in a particular case, profit, income) as a result of choosing one of alternative options use of resources and thereby forego other opportunities. The value of lost profits is determined by the utility of the most valuable of the discarded alternatives. Opportunity costs are an integral part of any decision making.
Opportunity costs are not expenses in the accounting sense, they are just an economic construct for accounting for lost alternatives.
If there are two investment options, A and B, and the options are mutually exclusive, then when assessing the profitability of option A, it is necessary to take into account the lost income from not accepting option B as the cost of a lost opportunity, and vice versa.
Opportunity "explicit" and "implicit" costs
The majority of production costs comes from the use of production resources. If the latter are used in one place, they cannot be used in another, since they have such properties as rarity and limitation. For example, money spent on buying a blast furnace to produce pig iron cannot simultaneously be spent on producing ice cream. As a result, by using a resource in a certain way, we lose the opportunity to use this resource in some other way.
Due to this circumstance, any decision to produce something necessitates the refusal to use the same resources for the production of some other types of products. Thus, costs represent opportunity costs.
Opportunity costs are the costs of producing a good, assessed in terms of the lost opportunity to use the same resources for other purposes.
Opportunity Cost Curve

In conditions of limited resources, it is impossible to increase the consumption of one good without reducing the consumption of another good. Suppose: goods X and Y are produced in society.
The production of additional units of product X can be achieved by using a certain set of production factors. But due to limited resources, this number of factors will not be used to produce goods Y. Everything that society could have received, but due to limited resources, did not receive and missed this opportunity is the cost of lost opportunity. If three units of Y must be given up to produce X, then these three units not produced determine the opportunity cost of producing a unit of X.
The value of lost opportunity costs (opportunity costs) is the monetary proceeds from the most profitable of all alternative uses of resources.
Limited resources give rise to the fundamental economic problem of choice: what goods and services a society should produce with limited amounts of land, labor and capital.
RATIONAL CHOICE
is a choice that is made based on a comparison of the benefits and opportunity costs of any decision. In this case, those actions are selected that are most economically beneficial - i.e. bring greatest benefits compared to costs
MARGINAL COST
- additional costs for applying additional effort (or producing an additional unit of output, if this unit can be measured quantitatively).
MARGINAL BENEFITS
- additional benefit from putting in extra effort (or profit from selling an additional unit of product).
A visual representation of the problem of limited resources and the need for choice is provided by the production possibilities curve.

The principle of comparative advantage means that even in the absence of absolute advantages (lower absolute production costs for all goods), a country can profitably and effectively participate in world trade. To do this, it is necessary to have relatively, that is, comparatively lower costs for some goods. Then the country will have a comparative advantage in these goods. Specialization based on the principle of comparative advantage contributes to more effective placement and use of resources, improving the level and quality of life of the population, and ultimately dynamic economic growth.

The history of the appearance of the concept in Russian economic vocabulary is connected with the work of the great English economist David Ricardo and with the translation of English comparative advantages into Russian.

Comparative from Latin compare- connect, associate, which follows from com- (together) + par equal, identical; identical. In the primary sense, a more accurate translation of English compare- to put on an equal footing, to compare, to compare, to distinguish. This etymological excursion allows us to more accurately determine the relationship between the concepts of comparative advantage and competitive advantage, as well as the content of the conclusion that comparative advantage is the basis competitive advantages(see competition).

The principle of comparative advantage as a basis international trade

It is obvious that international trade develops because it brings benefits to the countries participating in it. What lies behind this gain from international trade? The main prerequisite for the emergence of any market is the division of labor. This is also true for the global market. As was clarified above, in the case of the world market and international trade we are talking about the international division of labor, entailing international cooperation of labor, i.e., intercountry exchange of material goods. The international exchange of goods and services, which is based on MRI, is mutually beneficial for all countries participating in the world market. International trade is a means by which countries, by developing specialization, can increase the productivity of existing resources and thus increase the volume of goods and services produced and increase the level of welfare. The above thesis also has a theoretical justification - the principle of comparative advantage, which was formulated by David Ricardo.

The theory of comparative advantage operates on the concept of opportunity cost. Alternative price - working hours required to produce a unit of one good, expressed in terms of the labor time required to produce a unit of another good. In our example, the alternative price of goods 1 (opportunity costs) will be A1/A2 for country I, and A1/A2 for country II, where A1 and A2 are the time required to produce goods 1 and 2 in 1, respectively. th country. Indicators with “shades” will reflect the situation in country II.

So, the theory of comparative advantage - if countries specialize in the production of those goods that they can produce at a relatively lower cost than other countries, then trade will be mutually beneficial for both countries, regardless of whether production in one of them is absolutely more more effective than the other.

FYI. If it turned out that A1< A1", а А2" < А2, то можно было бы констатировать, что страна 1 имеет абсолютное преимущество в производстве товара I, поскольку на производ­ство этого товара в стране I затрачивается меньше времени, чем в стране II, а страна II по аналогичным причинам имеет абсо­лютное преимущество в производстве товара 2.

If A1/A2< А1"/А2", это означает, что затраты на производст­во товара I, выраженные через затраты на производство товара 2 в стране I ниже, чем аналогичный показатель для страны II. Следовательно» 1st country will export product I to country II, while country II will sell product 2 on the world market.

Let's consider the situation with comparative advantages using the example of two countries, England and Portugal, and two goods - cloth and wine. Information on the production of these goods in the closed economies of England and Portugal is presented in columns 2-4 of the table.

Time to produce a unit of cloth and a unit of wine in England and Portugal

At first glance, international trade for England is beneficial from all points of view, since the absolute advantage in the production of both goods 1 and goods 2 here belongs to Portugal, i.e. 40< 60, и 45 < 50. Для Португалии ситуация выглядит сложнее. Португалия обладает абсолютным преимуще­ством и в производстве вина и в производстве сукна - (A1 < А1"), (А2 < А2"), однако A1/A2 < A1"/A2" (40/45 < 60/50). Это означает, что относительное (сравнительное) преимущество в производстве вина принадлежит Португалии, а относительное преимущество в производстве сукна - Англии, т. е. для Португалии имеет смысл специализироваться в производстве вина, а для Англии - сукна, поскольку А2"/A1" < A2/A1 (50/60 < 45/40), что в конечном итоге обеспечит выгоду для обеих стран. Если Португалия откажется от производства сукна и увеличит объем производства вина до двух единиц (причем 2-ю единицу вина она будет обменивать на 1 единицу сукна, на производстве которого специализируется Англия, отказавшаяся от производства вина), то затраты Порту­галии сократятся с 85 до 80 часов (2 х 40), а Англии - с 110 до 100 часов (2 х 50). Общие же затраты на производство данного объема продукции сократятся на 15 часов (195-180).

Such an exchange is beneficial for both countries, since the countries’ needs for both wine and cloth will be satisfied at the same level, but labor costs for producing a given volume of products will be reduced. The theory of comparative advantage is valid for any number of countries and any number of goods. It is still, despite clarifications and additions and other theories of international trade, the prevailing concept, clearly proving the existence of gains from world trade for all countries participating in it.

Production possibility curve(transformation curve) ( Production possibility curve) is a set of points that show various combinations of maximum production volumes of several (usually two) goods or services that can be created under conditions of full employment and the use of all resources available in the economy.

The production possibilities curve reflects at each point the maximum volume of production of two products with different combinations of them, which allow the full use of resources. Moving from one alternative to another, the economy switches its resources from one product to another.