Opportunity Cost - Economics Concepts, Business Economics & Finance | Business Economics & Finance - B Com PDF Download

Opportunity cost is the estimated return of investments you don't make compared to the expected return of investments you do make. It's an important factor to consider when allocating time or resources to any type of project (essentially, "would my time or money be better spent elsewhere?"). 

Why is opportunity cost important?

Opportunity cost is one of the first terms that is introduced to students of economics, but it's not always well-known outside of those circles. For ecommerce merchants, who come from a variety of backgrounds and have different sets of skills and experiences, the concept may be totally unknown.

There's good news, though. The principles behind opportunity cost are being applied in some fashion by many store owners, even if they've never heard of the term itself. In the long view, understanding opportunity cost is an important part of making smart business decisions. Here's a look at the technical and practical definitions of the term, as well as how it applies specifically to ecommerce and the people who run online stores.

The technical definition

One textbook definition of opportunity cost is provided by the Merriam-Webster dictionary, which says the term refers to "the added cost of using resources (as for production or speculative investment) that is the difference between the actual value resulting from such use and that of an alternative (as another use of the same resources or an investment of equal risk but greater return)" (1). In abstract, technical terms, this is a strong definition - but it means little to those who aren't students of economics or consistently involved in a related field.

A more approachable definition is to call opportunity cost the difference between a chosen action, such as a purchase or investment, and the other seemingly viable opportunities that are also available. The cost in this case is the lost potential for a positive outcome, which is discarded or lost because the decision-maker has chosen a different purchase, strategy or other economic decision because there are only limited economic resources available.

Examples

A concrete example of opportunity cost can make the idea easier to understand. Consider the owner of a building who decides that her vacant first-floor space will become a restaurant. The opportunity cost of making such a decision is that the space can no longer be used for a different purpose, such as a retail store or an office space that's rented to another party.

Another example uses a farmer to display the same concept. Once a farmer chooses a crop - for example's sake, cucumbers - the limited resource of available land can no longer be used to grow another crop, such as potatoes or carrots (2). The opportunity cost of growing cucumbers on a finite piece of farming land is that other crops can't be grown at the same time.

Opportunity cost is tied to the concept of risk, and can be viewed through that lens. Opportunity cost is, in many ways, another way of describing the relative risks of choosing one option over another. The risk of one option providing a better or worse return than another is at the heart of the concept.

One important part of the overall concept to note is that opportunity cost may end up being positive or negative. In the example above, the farmer may have made the right decision, making more money by selling and otherwise using his cucumber crop than he would have with the potatoes or carrots. The converse is also true. Various market factors during the course of the growing season could make potatoes especially valuable and bring cucumbers below their normal price.

The other crucial component of opportunity cost is that it doesn't only apply to financial concerns. While money is often the thing in mind when the various options are considered, other resources such as time and labor can be involved as well. For example, the financial cost of the farmer planting two different crops may be the same, but one could involve significantly more labor in terms of planting or harvesting. The opportunity cost of the more labor-intensive crop is more time spent working in the field, as opposed to the other option.