Question

QUESTION 36 What is an opportunity cost? Suppose you own a business and spent $100,000 on materials. You observed that the prevailing interest rate is 5%. You also noted that if you worked for a company, your income wopld be $50,000. What is your opportunity cost for owning a business?

Answer 1

OPPORTUNITY COST:

Opportunity cost is determined as the lost earnings/income in the next best alternative if didnot do what we are doing now for eg: If we are using a floor as our office which we would have normally given for rent and earned $1000 then the rent we lost because of setting a office is opprtunity cost. In simple words, Opportunity cost is the forgone benefit that would have been derived by an option not chosen.

In your example

1) If we bought materials worth $1,00,000 for the business it is operating cost as it is the cost incurred to run the operations of the business, hence the interest of 5% we lose on investment of money in purchasing goods is not opportunity cost( the answer would be different if we invested money in purchasing any stock)

2) The income you lose $50,000 is definitely a opportunity cost for owning and running business it is your lost income due to starting business.

Thank you.