The whole essence of economics theory is to try to satisfy mans unlimited want through the scarce means provided by nature. The scarcity of these resources forms the basis of opportunity costs in economics. Scarcity in resources, results in a need to make tradeoff between different available opportunities that have to be satisfied using the same means. This implies that scarcity gave birth to the theories surrounding opportunity costs. The process of fulfilling some wants and desires of limited resources creates the term choice. All the decision that involves making a choice between different alternatives has an opportunity cost. The ability to choose among different opportunities will be based on the opportunity cost or the value of the foregone activity. Choosing one alternative means that we have to give up the other opportunities. Every choice has an associated cost and the value that is foregone is the alternative with the highest value. One difference between the accounting costs of goods or services and opportunity cost is that opportunity cost is the cost of the next best alternative.
There is also a significant difference between accounting costs and opportunity cost. This can be illustrated with the example of an employee who wants to quit her job and pursue a masters Degree in economics that will take three Years. Suppose we assume that the total costs charged for a masters Degree in that University is $40,000 on tuition, accommodation and project fees. Then the accounting costs for doing a masters Degree will be $40,000. On the other hand if we also assume that the employee was receiving a salary of $40,000 per year and there is a policy in the company to increase the employee’s salary by 5% each year then the opportunity cost of the employees will be. The salary that the employees ought to have received in the three years plus the accounting costs for doing the masters. Mathematically the opportunity cost is. $44,100+$40,000+$42,000+$40,000=$166,100. It is now clear from the example that opportunity costs is higher than Accounting costs.
An Opportunity cost is one of the useful techniques that are applied in the decision making under the cost benefits analysis. Opportunity costs can be in monetary or non monetary terms. An example of the monetary opportunity cost is in the above example. Opportunity cost is usually expressed as a relative ratio of one choice of an opportunity relative to the other opportunity. Opportunity cost has a lot of practical applications in real life. One such area of application is making consumer’s choice. The level of satisfaction of a consumer will be used to judge the best good or service. The second best good in terms of satisfaction will be the foregone choice. Opportunity costs will also be used to get the cost of borrowing capital from different sources: issuing ordinary shares; issuing debentures or borrowing a long term loan. Other area of application will be in analysis of comparative advantages, Time management, and production possibilities and in junior school to help students do the best career choices