Opportunity Cost Concept

Opportunity cost is the foregone value associated with the current rather than next-best use of an asset. In other words, cost is determined by the highest-valued opportunity that must be foregone to allow current use. The cost of aluminum used in the manufacture of soft drink containers, for example, is determined by its value in alternative uses. Soft drink bottlers must pay an aluminum price equal to this value, or the aluminum will be used in the production of alternative goods, such as airplanes, building materials, cookware, and so on. Similarly, if a firm owns capital equipment that can be used to produce either product A or product B, the relevant cost of product A includes the profit of the alternative product B that cannot be produced because the equipment is tied up in manufacturing product A.

The opportunity cost concept explains asset use in a wide variety of circumstances. Gold and silver are pliable yet strong precious metals. As such, they make excellent material for dental fillings. However, when speculation drove precious metals prices skyrocketing during the 1970s, plastic and ceramic materials became a common substitute for dental gold and silver. More recently, lower market prices have again allowed widespread dental use of both metals. Still, dental customers must be willing to pay a price for dental gold and silver that is competitive with the price paid by jewelry customers and industrial users.

explicit cost

Out-of-pocket expendi-

implicit cost

Noncash costs

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