Opportunity Cost
Opportunity Cost is the potential benefit that an individual or an entity loses by choosing one alternative over the other. It plays a crucial role in many aspects of a firm’s decision-making. It allows an organisation to decide on which opportunity to choose and which ones to forego. For example, a firm can raise capital for its operations through either debt or equity. The company has to evaluate these two alternatives and select the option which they believe will be more profitable for them, by conducting a cost-benefit analysis. If the firm decides to choose an equity to finance its operations, the Opportunity Cost would be the potential benefits it will lose by not selecting debt. Opportunity Cost is a part of the Economic Cost.
Economic Cost
The Economic Cost looks at the overall profits or losses of choosing one alternative over the other in terms of resources, time and cost. It is one of the most valuable methods for any organisation that wants to make informed decisions. It also looks at the possible gains or losses it had to forego by not choosing the other alternative. It includes both the accounting cost and Opportunity Cost for each alternative as a part of the cost-benefit analysis of evaluating all options. We can take the above example to understand this concept. The firm has to decide on whether to raise capital through equity or debt. The Economic Cost of choosing equity would be the total of the Opportunity Cost (the potential benefits of choosing debt) and the accounting cost (the expenses incurred in raising finance through equity).
Differences between Opportunity Cost and Economic Cost
Some of the significant differences between Opportunity Cost and Economic Cost are as follows:
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Opportunity Cost |
Economic Cost |
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Definition |
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Opportunity Cost is the potential benefit that an individual or an entity loses by choosing one alternative over the other. |
Economic Cost looks at the overall profits or losses of choosing one alternative over the other in terms of resources, time and cost. |
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Scope |
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Opportunity Cost has a narrower scope since it is a part of the overall Economic Cost |
Economic Cost has a broader scope since it includes the Opportunity Cost. |
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Accounting Cost |
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Opportunity Cost does not include the accounting cost of not choosing a particular alternative. |
Economic Cost includes the accounting cost of not choosing a particular alternative. |
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Example |
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If a group of people are building a school, the Opportunity Cost would be the money they could have made by carrying out some other economic activity. |
If a group of people are building a school, the Economic Cost would be the total accounting cost (explicit cost of building a well) and the Opportunity Cost (the money they could have made by carrying out some other economic activity). |
Conclusion
There are significant differences between Opportunity Cost and Economic Cost. However, both are an essential part of the overall cost-benefit analysis that every individual or entity does, before undertaking any economic activity.
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