Meaning of Opportunity Cost and Its Economic Significance

Updated on February 27, 2020

Introduction to Cost Function

The relationship between cost and output is known as the cost function. Cost functions are derived from production functions. The production function expresses the functional relationship between input and output. In simple terms, the production function states that output depends upon various quantities of inputs. If prices of inputs are known, we can calculate the costs of production. The cost of production of a commodity is the aggregate of prices paid for the factors of production used in producing that commodity.

Opportunity Cost

Modern economists have rejected the labor and sacrifices nexus to represent real cost. Rather, in its place they have substituted opportunity or alternative cost.

The concept of opportunity cost occupies an important place in economic theory. The concept was first developed by an Austrian economist, Wieser. The other notable contributors are Daven Port, Knight, Wicksteed and Robbins. The concept is based on the fundamental fact that factors of production are scarce and versatile.

Our wants are unlimited. The means to satisfy these wants are limited, but they are capable of alternative uses. Therefore, the problem of choice arises. This is the essence of Robbins’ definition of economics.

The opportunity cost of anything is the alternative that has been foregone. This implies that one commodity can be produced only at the cost of foregoing the production of another commodity. As Adam Smith observed, if a hunter can bag a deer or a beaver in the course of a single day, the cost of a deer is a beaver and the cost of a beaver is a deer. A man who marries a girl is foregoing the opportunity of marrying another girl. A film actor can either act in films or do modeling work. She cannot do both the jobs at the same time. Her acting in film results in the loss of an opportunity of doing modeling work.

In the words of Prof. Byrns and Stone “opportunity cost is the value of the best alternative surrendered when a choice is made.”

In the words of John A. Perrow “opportunity cost is the amount of the next best produce that must be given up (using the same resources) in order to produce a commodity.”

Importance of the Concept of Opportunity Cost

1. Determination of Relative Prices of goods

The concept is useful in the determination of the relative prices of different goods. For example, if a given amount of factors can produce one table or three chairs, then the price of one table will tend to be three times equal to that one chair.

2. Fixation of Remuneration to a Factor

The concept is also useful in fixing the price of a factor. For example, let us assume that the alternative employment of a college professor is work as an officer in an insurance company at a salary of $4,000 per month. In such a case, he has to be paid at least $4,000 to continue to retain him in the college.

3. Efficient Allocation of Resources

The concept is also useful in allocating the resources efficiently. Suppose, opportunity cost of 1 table is 3 chairs and the price of a chair is $100, while the price of a table is $400. Under such circumstances, it is beneficial to produce one table rather than 3 chairs. Because, if he produces 3 chairs, he will get only $300, whereas a table fetches him $400, that is, $100 more.


The concept has the following drawbacks:

1. Specific

If a factor’s service is specific, it cannot be put to alternative uses. The transfer cost or alternative cost in such a case is zero. This is pure rent, according to Mrs. Joan Robinson.

2. Inertia

Sometimes, factors may be reluctant to move to alternative occupations. In such a case, a payment exceeding the pure transfer cost will have to be made to induce it to take to an alternative occupation.

3. Perfect Competition

The concept rests on the assumption of perfect competition. However, perfect competition is a myth, which seldom prevails.

4. Private and Social Costs

A discrepancy is likely to arise between private and social costs. For example, let us assume that a chemical factory discharges industrial refuse into a river. This causes serious health hazards, which cannot be measured in money terms.

5. Alternatives are not clearly known

The foregone opportunities are often not ascertainable. This also poses a serious limitation of the concept.

Other Types of Cost

Money Cost and Real Cost

Money cost or nominal cost is the total money expenses incurred by a firm in producing a commodity. It includes the following elements:

  1. Cost of raw materials
  2. Wages and salaries of labor
  3. Expenditure on machinery and equipment
  4. Depreciation on machines, buildings and such other capital goods
  5. Interest on capital
  6. Other expenses like advertisement, insurance premium and taxes.
  7. Normal profits of the entrepreneur

Real cost is a subjective concept. It expresses the pains and sacrifices involved in producing a commodity. Marshall defined real cost as follows, “The exertions of all the different kinds of labor that are directly or indirectly involved in making it; together with the abstinences or rather the waiting required for saving the capital used in making it.”

However, real costs are not amenable to precise measurement. Modern economists therefore prefer the concept of opportunity cost.

Private, External and Social Costs

Sometimes, there is a discrepancy between the cost incurred by a firm and the cost incurred by the society. For example, an oil refinery discharges its wastes in the river causing water pollution. Likewise, various types of air pollution and noise pollution are caused by various agencies engaged in production activities. Such pollutions result in tremendous health hazards, which involve cost to the society as a whole. A cost that is not borne by the firm, but is incurred by others in the society is called an external cost.

The true cost to the society must include all costs, regardless of the persons on whom its impact falls and its incidence as to who bear them.

Thus, social cost = private cost + external cost

Or external cost = social cost – private cost

Implicit Cost and Explicit Cost

Explicit costs are those costs, which are actually paid by the firm. To put it in other words, explicit costs are paid out costs. Explicit costs include wages and salaries, prices of raw materials, amounts paid on fuel, power, advertisement, transportation, taxes and depreciation charges. Explicit costs are recorded in the firm’s books of account.

Implicit costs are the imputed value of the entrepreneur’s own resources and services. In other words, implicit costs are costs, which self-owned and self-employed resources could have earned in their best alternative uses. It refers to the highest income, which might have been received by him if he has let his labor, building and money to someone else. These costs are frequently ignored in calculating the expenses of production.

Historical and Replacement Cost

Historical cost refers to the cost of an asset, acquired in the past whereas replacement cost refers to the cost, which has to be incurred for replacing the same asset.

Increment and Sunk costs

The increment costs are the additions to costs resulting from a change in product lines, introduction of a new product, replacement of obsolete plant and machinery, etc.

Sunk costs are those which cannot be altered, increased or decreased by changing the rate of output and the level of business activity. All the past costs are considered as sunk costs because they are known and given and cannot be revised as a result of changes in market conditions.


    0 of 8192 characters used
    Post Comment
    • profile image


      2 weeks ago

      What is the importance of opportunity cost to West African Countries

    • profile image


      2 weeks ago

      What is the importance of opportunity cost to west african countries

    • profile image


      4 months ago

      Why is opportunity cost also refers as a real cost?

    • profile image


      4 months ago

      Thanks.. it really help me with my assignment.

    • profile image


      5 months ago


    • profile image


      5 months ago

      Please what is the relevant of opportunity in decision making within the scope of limited resources

    • profile image


      5 months ago

      Is helpful and it help me with my assignment

    • profile image

      Jyoti Prajapati 

      6 months ago

      Really very helpful

    • profile image

      Ife Ade 

      8 months ago

      So brainy thanks for helping me with my assignment

    • profile image


      8 months ago


    • profile image


      9 months ago


    • profile image


      9 months ago



    This website uses cookies

    As a user in the EEA, your approval is needed on a few things. To provide a better website experience, uses cookies (and other similar technologies) and may collect, process, and share personal data. Please choose which areas of our service you consent to our doing so.

    For more information on managing or withdrawing consents and how we handle data, visit our Privacy Policy at:

    Show Details
    HubPages Device IDThis is used to identify particular browsers or devices when the access the service, and is used for security reasons.
    LoginThis is necessary to sign in to the HubPages Service.
    Google RecaptchaThis is used to prevent bots and spam. (Privacy Policy)
    AkismetThis is used to detect comment spam. (Privacy Policy)
    HubPages Google AnalyticsThis is used to provide data on traffic to our website, all personally identifyable data is anonymized. (Privacy Policy)
    HubPages Traffic PixelThis is used to collect data on traffic to articles and other pages on our site. Unless you are signed in to a HubPages account, all personally identifiable information is anonymized.
    Amazon Web ServicesThis is a cloud services platform that we used to host our service. (Privacy Policy)
    CloudflareThis is a cloud CDN service that we use to efficiently deliver files required for our service to operate such as javascript, cascading style sheets, images, and videos. (Privacy Policy)
    Google Hosted LibrariesJavascript software libraries such as jQuery are loaded at endpoints on the or domains, for performance and efficiency reasons. (Privacy Policy)
    Google Custom SearchThis is feature allows you to search the site. (Privacy Policy)
    Google MapsSome articles have Google Maps embedded in them. (Privacy Policy)
    Google ChartsThis is used to display charts and graphs on articles and the author center. (Privacy Policy)
    Google AdSense Host APIThis service allows you to sign up for or associate a Google AdSense account with HubPages, so that you can earn money from ads on your articles. No data is shared unless you engage with this feature. (Privacy Policy)
    Google YouTubeSome articles have YouTube videos embedded in them. (Privacy Policy)
    VimeoSome articles have Vimeo videos embedded in them. (Privacy Policy)
    PaypalThis is used for a registered author who enrolls in the HubPages Earnings program and requests to be paid via PayPal. No data is shared with Paypal unless you engage with this feature. (Privacy Policy)
    Facebook LoginYou can use this to streamline signing up for, or signing in to your Hubpages account. No data is shared with Facebook unless you engage with this feature. (Privacy Policy)
    MavenThis supports the Maven widget and search functionality. (Privacy Policy)
    Google AdSenseThis is an ad network. (Privacy Policy)
    Google DoubleClickGoogle provides ad serving technology and runs an ad network. (Privacy Policy)
    Index ExchangeThis is an ad network. (Privacy Policy)
    SovrnThis is an ad network. (Privacy Policy)
    Facebook AdsThis is an ad network. (Privacy Policy)
    Amazon Unified Ad MarketplaceThis is an ad network. (Privacy Policy)
    AppNexusThis is an ad network. (Privacy Policy)
    OpenxThis is an ad network. (Privacy Policy)
    Rubicon ProjectThis is an ad network. (Privacy Policy)
    TripleLiftThis is an ad network. (Privacy Policy)
    Say MediaWe partner with Say Media to deliver ad campaigns on our sites. (Privacy Policy)
    Remarketing PixelsWe may use remarketing pixels from advertising networks such as Google AdWords, Bing Ads, and Facebook in order to advertise the HubPages Service to people that have visited our sites.
    Conversion Tracking PixelsWe may use conversion tracking pixels from advertising networks such as Google AdWords, Bing Ads, and Facebook in order to identify when an advertisement has successfully resulted in the desired action, such as signing up for the HubPages Service or publishing an article on the HubPages Service.
    Author Google AnalyticsThis is used to provide traffic data and reports to the authors of articles on the HubPages Service. (Privacy Policy)
    ComscoreComScore is a media measurement and analytics company providing marketing data and analytics to enterprises, media and advertising agencies, and publishers. Non-consent will result in ComScore only processing obfuscated personal data. (Privacy Policy)
    Amazon Tracking PixelSome articles display amazon products as part of the Amazon Affiliate program, this pixel provides traffic statistics for those products (Privacy Policy)
    ClickscoThis is a data management platform studying reader behavior (Privacy Policy)