Opportunity Cost

Opportunity cost is a concept used for evaluation of alternative uses of resources. Decision makers select that alternative use of resources from which they expect the maximum net return. Opportunity cost is the net return that could be obtained from the second best alternative that has been rejected.

Suppose a trader of agricultural inputs has one million rupees to invest. Different avenues of investment available to him are as under:

Alternative 1: Investment in the purchase of pesticides, expected return Rs.250,000.

Alternative 2: Investment in the purchase of fertilizers, expected. return Rs.200,000.

Alternative 3: Lend out the money to a fellow trader, expected return Rs.100,000.

The trader will choose the alternative 1 as its expected return is maximum. His opportunity cost will be Rs200,000 i.e. the expected revenue from second best alternative.

Suppose, due to some emergency the trader is unable to invest the money in alternative 1 or 2 and has lent it out for a return of Rs.100,000. The difference of net return between the best alternative and the alternative chosen is called opportunity loss. In this case Rs.150,000 (i.e. Rs.250,000 — Rs. 100, 000.

A well known example of opportunity cost is interest on capital debited in profit and loss acco,..ht. Most of the times opportunity cost is not recorded in books 0:accounts but it is always relevant to decisions.

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