Many times, we seem to have to choose between two things. And there is always one trade-off or the other to make. And we never have all we want because everything in life has an opportunity cost.
Opportunity cost is otherwise known as forgone alternatives. It is the value of that which you have to give up in place of another. It is an economic term or concept that describes the art of better decision-making in life and other situations.
Besides opportunity cost being an economic concept, is there a way to use this type of calculation in your life? Keep reading to learn more.
What is the opportunity cost?
It is one of the foundational concepts in economics and borders on the best-forgone alternative. Usually, it originates from the existence of scarcity and scarce resources. Because human wants are insatiable, people are unable to fulfill or satisfy their needs. Therefore, they must satisfy some at the expense of others. It means that when we pursue one activity over another, the forgone activity becomes the opportunity cost of the pursued training.
Types of opportunity cost
Often, the forgone alternative may involve some monetary compensation. Other times, it may not require any financial payment. The former gives us explicit cost, while the latter provides implicit cost. Both types of cost give rise to two significant types of opportunity cost –explicit cost and implicit cost.
This type of forgone alternative usually involves a kind of monetary compensation. Typically, the money payment compensates the one who has incurred the original opportunity cost by forgoing some satisfaction. As a result, the money paid transfers the opportunity cost of the foregone alternative from the person receiving payment to the one making or offering the amount.
A life example that explains the explicit cost
A worker in a company is supposed to be the original bearer of the opportunity cost because the worker has to forgo comfort and time for pleasure. However, because the worker is paid wages, the forgone alternative paid in monetary terms shifts to the employer who makes payment. Therefore, the employer bears the explicit cost.
This type of opportunity cost does not involve any monetary compensation. In this type of forgone alternative, the person who should initially bear the forgone alternative doesn’t get any financial compensation. And the opportunity cost does not shift to anybody since there is no one to pay for it with money.
A life example that explains the implicit cost
A worker who works at his primary job and at the same time works the closing shift at his father’s company. Because he works the closing shift at his father’s company, he does not get to have extra time for leisure. Since his father’s company worker works to build the family enterprise, he does not get any wages. As a result, the forgone time for leisure is his implicit cost.
How to calculate opportunity cost
To correctly calculate this cost, we need explicit knowledge of the cost and benefits of all options available. Working out this cost per time guides both individuals and corporate entities in proper decision-making. And sound decision-making brings progress and profit.
Mathematically, we can derive or calculate the forgone alternative by subtracting the return on chosen option from the return on a best-forgone alternative.
How to use opportunity cost calculation in your life.
Trying to use this cost calculation in your life would mean accounting for the forgone alternatives in your life or business. Even though we have an established formula for calculating this cost, most people fail to give it the attention required. The reason is that it is a very abstract concept. As a result, sometimes, it can prove intangible and therefore easy to neglect.
How paystubsnow helps entrepreneurs manage cost-effectively
As a business owner, because you incur certain costs due to paying employee salaries, it becomes necessary to understand how much you spend. By paying employee salaries, the original opportunity cost of your employees is transferred to you that pays wages. Therefore it is essential to understand how much of the explicit cost you incur indeed.
With paystubsnow, you can generate electronic paystubs for your employees as well as electronic invoices to stay on top of customer or client obligations. Some other utilities you can derive from the online paystub generator are 1099 and w2 forms. All of which you can get in your email within minutes of generation.
FAQS: How do you use opportunity cost in everyday life?
How do you use opportunity cost in everyday life?
We use this cost in everyday life each time we have to make choices and decisions. The fact that we have to always choose one thing over another is the practice of forgone alternatives. As a result, this cost can influence to a great extent vast aspects of our lives, from family life to diet, health, finances, career, and so on. A clear example would be choosing to walk home from work rather than taking the bus. Thus, the forgone alternative is the time you spend walking home because you decided not to take the bus.
How do you calculate opportunity cost?
Because calculating this cost is pretty abstract, it can seem quite daunting to pin down. Regardless, the simplest way to figure it out is to consider what you have to sacrifice or forgo in place of another.
What is the importance of opportunity cost?
It is crucial in executing the best form of decision making, especially considering the scarcity of resources we always have to deal with. That way, we can adequately maximize our little resources for more profits.