Opportunity cost is the term for lost profits when one of the existing alternatives is chosen over another. The amount of lost profits is measured by the utility of the most valuable alternative that was not chosen to replace the other. Thus, opportunity costs occur wherever acceptance is needed. rational decision and there is a need to choose between the available options.
The term was first introduced by Austrian school economist Friedrich von Wieser in 1914 in his work The Theory of the Social Economy.
Thus, the opportunity cost is the cost of any, measured in terms of the value of the next best alternative, that is withheld. it key concept in the economy, providing the most rational and efficient use of limited resources. These costs do not always mean financial costs. They also signify the real value of products that are abstained from, Lost time, pleasure, or any other benefit that provides utility.
There are many examples of opportunity costs. Every person is faced daily with the need to make a choice between available options. For example, a person who wants to watch two interesting TV programs on TV at the same time on different channels, but does not have the opportunity to record one of them, will be forced to watch only one program. Thus, his opportunity cost would be not being able to watch one of the programs. Even if he has the opportunity to record one of the programs while watching the other, even then there will be an opportunity cost equal to the time spent watching the program.
Opportunity costs can also be assessed in the decision-making process in economic activity. For example, if on farming If you can produce 200 tons of barley or 400 tons of rye, then the opportunity cost of producing 200 tons of barley is 400 tons of wheat, which you have to give up.
To see how the opportunity cost can be estimated, let's take Robinson on a desert island as an example. Suppose that near his hut he grows two crops: potatoes and corn. Land plot limited: on one side - the ocean, on the other - the jungle, on the third - rocks, on the fourth - Robinson's hut. Robinson decides to increase corn production. And he can do this in only one way: to increase the area allocated for corn by reducing the area occupied by potatoes. The opportunity cost of producing each subsequent cob of corn in this case can be expressed in terms of potato tubers that Robinson did not receive when using the potato land resource to grow corn.
But this example is for two products. But what if there are dozens, hundreds, thousands of them? Then money comes to the rescue, by means of which all other goods are commensurate.
Opportunity cost can be the difference between the profit that could be obtained with the most profitable of all alternative ways use of resources, and actual profits.
But not all entrepreneurial costs act as opportunity costs. In any way of using resources, the costs that the manufacturer bears in an unconditional manner (for example, registration of an enterprise, rent, etc.) are not alternative. These non-opportunity costs do not participate in the process of economic choice.
Opportunity costs faced by firms include payments to workers, investors, and owners. natural resources. All these payments are made in order to attract factors of production, diverting them from alternative uses.
From the point of view of economics, opportunity costs can be divided into two groups: "explicit" and "implicit".
Explicit costs are opportunity costs that take the form of cash payments to suppliers of factors of production and intermediate products.
Explicit costs include: wages of workers (cash payment to workers as suppliers of the factor of production - labor); cash costs for the purchase or payment for the lease of machine tools, machinery, equipment, buildings, structures (monetary payment to suppliers of capital); payment of transport costs; utility bills (electricity, gas, water); payment for services of banks, insurance companies; payment of suppliers material resources(raw materials, semi-finished products, components).
Implicit costs are the opportunity costs of using resources owned by the firm itself, i.e. unpaid expenses.
Implicit costs can be represented as:
- 1. Cash payments that the firm could receive with a more profitable use of its resources. This can also include lost profits ("opportunity costs"); the wages that an entrepreneur could have earned by working elsewhere; interest on capital invested in securities; land rents.
- 2. Normal profit as the minimum remuneration to the entrepreneur, keeping him in the chosen branch of activity.
For example, an entrepreneur engaged in the production of fountain pens considers it sufficient for himself to receive a normal profit of 15% of the invested capital. And if the production of fountain pens gives the entrepreneur less than a normal profit, he will transfer his capital to industries that give at least a normal profit.
3. For the owner of capital, implicit costs are the profit that he could receive by investing his capital not in this, but in some other business (enterprise). For the peasant - the owner of the land - such implicit costs will be the rent that he could receive by renting out his land. For an entrepreneur (including a person engaged in ordinary labor activity) as implicit costs will be the wages that he could receive (for the same time), working for hire at any firm or enterprise.
Thus, in the cost of production, Western economic theory includes the income of the entrepreneur (Marx called it average profit on invested capital). At the same time, such income is considered as a payment for risk, which rewards the entrepreneur and stimulates him to keep his financial assets within the limits of this enterprise and not divert them for other purposes.
Examples of opportunity costs:
A person who has $15 can buy a CD or a shirt. If he buys the shirt, the opportunity cost is the CD and if he buys the CD, the opportunity cost is the shirt. If there are more choices than two, the opportunity cost is still just one item, never all of them.
When a person comes to the store and is forced to choose between a steak that costs $20 and a trout that costs $40. By choosing the more expensive trout, the opportunity cost is two steaks that could have been purchased with the money spent. And, on the contrary, choosing a steak, the cost will be 0.5 servings of trout.
Opportunity costs are assessed not only in monetary or essential conditions, but also in terms of anything that matters. For example, a person who wishes to watch each of two television programs broadcast at the same time and is unable to record one of them, and therefore can watch only one of the desired programs. Of course, if a person records one program while watching another, then the opportunity cost is the time the person spends watching the first program rather than the second. In the shop-to-customer situation, the opportunity cost of ordering both meals could be double the extra $40 to buy the second meal, and his reputation as he might be thought of as wealthy enough to spend that much on food . Also as an option. The family might decide to use the short vacation period to visit Disneyland instead of making home improvements. The opportunity cost here is covered by having happier children, so the bathroom renovation will have to wait another hour.
The consideration of opportunity costs is one of the main differences between the concept economic value and accounting cost. Estimating opportunity costs is fundamental to assessing the true cost of any course of action.
Note that the opportunity cost is not the sum of the available alternatives if these alternatives are, in turn, mutually exclusive.
Opportunity costs are sometimes difficult to imagine as a certain amount of rubles or dollars. In a widely and dynamically changing economic environment, it is difficult to choose The best way use of the available resource. In a market economy, this is done by the entrepreneur himself as the organizer of production. Based on his experience and intuition, he determines the effect of a particular direction of resource use. At the same time, income from lost opportunities (and hence the size of opportunity costs) are always hypothetical.
The accounting concept completely ignores the time factor. It estimates the costs based on the results of already completed transactions. And when determining the costs of lost opportunities, it is important to understand that the effect of any option for using a resource can manifest itself in different periods. The choice of an alternative is often associated with the answer to the question, what to prefer: quick profit at the cost of future losses or current losses for the sake of profit in the future? On the one hand, this complicates the assessment of costs. On the other hand, the complexity of the analysis turns into a plus for a more detailed consideration of all aspects of the future project.
The concept of opportunity cost is an effective tool in making effective economic decisions. Resource cost estimation is done here on the basis of a comparison with the best of competing, the most efficient method of using rare resources. The centrally controlled system has deprived business entities of independence in making strategic decisions. And that means the possibility of choosing the best alternatives. The central authorities themselves, even with the help of computers, were unable to calculate the optimal structure of production for the country. They could not find answers to the two main questions of the economy "what to produce?" and "how to produce?". Therefore, under these conditions, the result of opportunity costs was often a shortage of goods and low-quality products.
For a market economy, choice and alternativeness are integral features. Resources must be used in an optimal way, then they will bring maximum profit. Saturation with the goods and services that consumers need is a persistent outcome of the opportunity cost of the market system.
Workshop.
Suppose you have 800 rubles. If you decide to spend these 800 rubles. for a football ticket, what is your opportunity cost of going to a football match?
Opportunity costs, costs of lost profits or costs of alternative opportunities - a term denoting lost profits (in a particular case - profit, income) as a result of choosing one of the alternative options for using resources and, thereby, rejecting other opportunities. The amount of lost profit is determined by the utility of the most valuable of the discarded alternatives.
So in order to know the value of the opportunity cost, you need to know possible options use of these 800 rubles. For example, this amount could be spent on clothes worth 800 rubles, or on products, the total cost of which is also 800 rubles, etc. In this situation, we are faced with a choice and decided to spend 800 rubles. for a football ticket. The cost of purchased goods is the opportunity cost, equal to the cost of services that we sacrifice for the sake of choosing other services. opportunity cost in this example is the cost of goods and services that we gave up in order to purchase a ticket for football.
choice limited resource economic
Introduction
Opportunity cost, opportunity cost or opportunity cost (eng. Opportunity cost(s)) economic term, denoting the lost profit (in the particular case, profit, income) as a result of choosing one of the alternative options for using resources and, thereby, refusing other possibilities. The amount of lost profit is determined by the utility of the most valuable of the discarded alternatives. Opportunity costs are an inseparable part of any decision making.
Opportunity costs are not expenses in the accounting sense, they are just an economic construct for accounting for lost alternatives.
If there are two investment options, A and B, and the options are mutually exclusive, then when assessing the profitability of option A, it is necessary to take into account the lost income from not accepting option B as the cost of a missed opportunity, and vice versa.
1. Alternative "explicit" and "implicit" costs
Most of the cost of production is the use of production resources. If the latter are used in one place, then they cannot be used in another, since they have such properties as rarity and limitedness. For example, the money spent on the purchase of a blast furnace for the production of pig iron cannot be simultaneously spent on the production of ice cream. As a result, by using some resource in a certain way, we lose the ability to use this resource in some other way.
By virtue of this circumstance, any decision to produce something necessitates the refusal to use the same resources for the production of some other types of products. Thus, costs are opportunity costs.
Opportunity cost is the cost of producing a good valued in terms of the lost opportunity to use the same resources for other purposes.
To see how the opportunity cost can be estimated, let's take Robinson on a desert island as an example. Suppose that near his hut he grows two crops: potatoes and corn. The land plot is limited: on the one hand - the ocean, on the other - the jungle, on the third - rocks, on the fourth - Robinson's hut. Robinson decides to increase corn production. And he can do this in only one way: to increase the area allocated for corn by reducing the area occupied by potatoes. The opportunity cost of producing each subsequent cob of corn in this case can be expressed in terms of potato tubers that Robinson did not receive when using the potato land resource to grow corn.
But this example is for two products. But what if there are dozens, hundreds, thousands of them? Then money comes to the rescue, by means of which all other goods are commensurate.
Opportunity costs can act as the difference between the profit that could be obtained with the most profitable of all alternative ways of using resources, and the profit actually received.
But not all entrepreneurial costs act as opportunity costs. In any way of using resources, the costs that the manufacturer bears in an unconditional manner (for example, registration of an enterprise, rent, etc.) are not alternative. These non-opportunity costs do not participate in the process of economic choice.
In economics, opportunity costs do not always take the form of cash costs.
For example, an ice cream manufacturer decided to take a break and bought trips to the Canary Islands. The expenses that he made out of his own pocket act as opportunity costs: after all, for this amount he (the manufacturer) could expand the production of ice cream (buy or rent premises, purchase additional raw materials or equipment) if this production will bring profit. However, while vacationing in the Canary Islands, he does not receive the income from the expansion of production, which he could have received if he had not left and did not use this resource differently. Lost or not received income is also included in the opportunity costs, although it is not a direct monetary expense (this is not what he spent out of his own pocket, but what he did not receive in his own pocket).
Thus, the opportunity cost in the economy is the sum of opportunity cash costs and lost cash income.
Opportunity costs faced by firms include payments to workers, investors, and owners of natural resources. All these payments are made in order to attract factors of production, diverting them from alternative uses.
From an economic point of view, opportunity costs can be divided into two groups: "explicit" and "implicit".
Explicit costs are opportunity costs that take the form of cash payments to suppliers of factors of production and intermediate products.
Explicit costs include: wages of workers (cash payment to workers as suppliers of the factor of production - labor); cash costs for the purchase or payment for the lease of machine tools, machinery, equipment, buildings, structures (monetary payment to suppliers of capital); payment of transport costs; utility bills (electricity, gas, water); payment for services of banks, insurance companies; payment of suppliers of material resources (raw materials, semi-finished products, components).
Implicit costs are the opportunity costs of using resources owned by the firm itself, i.e. unpaid expenses.
Implicit costs can be represented as:
1. Cash payments that the firm could receive with a more profitable use of its resources. This can also include lost profits (“opportunity costs”); the wages that an entrepreneur could have earned by working elsewhere; interest on capital invested in securities; land rents.
2. Normal profit as the minimum remuneration to the entrepreneur, keeping him in the chosen branch of activity.
For example, an entrepreneur engaged in the production of fountain pens considers it sufficient for himself to receive a normal profit of 15% of the invested capital. And if the production of fountain pens gives the entrepreneur less than a normal profit, he will transfer his capital to industries that give at least a normal profit.
3. For the owner of capital, implicit costs are the profit that he could receive by investing his capital not in this, but in some other business (enterprise). For the peasant - the owner of the land - such implicit costs will be the rent that he could receive by renting out his land. For an entrepreneur (including a person engaged in ordinary labor activity), the implicit costs will be the wages that he could receive (for the same time) while working for hire at any firm or enterprise.
Thus, Western economic theory includes the income of the entrepreneur (in Marx it was called the average return on invested capital) in the cost of production. At the same time, such income is considered as a payment for risk, which rewards the entrepreneur and stimulates him to keep his financial assets within the limits of this enterprise and not divert them for other purposes.
2. Accounting for opportunity costs in small business
The formation of the composition of production costs and their accounting are important for any organization, small businesses especially need such formation.
Costs are the monetary expression of costs production factors necessary for the enterprise to carry out its production and commercial activities. They find their expression in terms of the cost of production, which characterize in monetary terms all the material costs and labor costs that are necessary for the production and sale of products.
The quantity of a product that a firm can offer on the market depends, on the one hand, on the level of costs (costs) for its production and on the price at which the product will be sold on the market, on the other. From this it follows that knowledge of the costs of production and sale of goods is one of the most important conditions for the effective management of the enterprise.
In real production activities it is necessary to take into account not only the actual monetary costs, but also the opportunity costs.
The opportunity cost of any solution is the best of all possible solutions. The opportunity cost of using resources is the cost of using resources at the best of other possible alternative uses. The opportunity cost of the labor time that an entrepreneur spends running his business is the wage he gives up by not selling his business. labor force to another, not his own enterprise, or the cost of free time, which the entrepreneur donated - whichever is greater. Therefore, the expected income from the type of activity in a small business, on average for the year, should exceed the maximum possible alternative income of an entrepreneur in another type of activity.
Opportunity costs include things like paying wages workers, investors, payment of resources. All these payments are intended to attract these factors, thereby diverting them from their alternative use.
Explicit costs are opportunity costs that take the form of direct (cash) payments for factors of production. These are such as: payment of wages, interest to the bank, fees to managers, payment to providers of financial and other services, payment of transportation costs and much more. But the costs are not limited to the explicit costs incurred by the enterprise. There are also implicit (implicit) costs. These include the opportunity costs of resources directly from the owners of the enterprise. They are not fixed in contracts and therefore remain under-received in material form. So, for example, steel used to make weapons cannot be used to make cars. Businesses usually do not record implicit costs in financial statements but that doesn't make them smaller.
Considering that small businesses are mainly firms and organizations with a small initial capital, and the organizers of such firms are often middle-class people who do not have the opportunity to constantly compensate for the losses of their enterprise. It can be concluded that accounting for opportunity costs by small businesses is mandatory. Because only with the help of this accounting, a small business will be able to exist and bring a stable income to the owner. Likewise, on initial stage work of a small business, accounting for opportunity costs can help its owner determine the feasibility of further work in his chosen industry. This is especially important for small businesses, because small business owners do not have the opportunity to risk the money invested in the business.
In fact, accounting for opportunity costs in small business is a condition for its existence.
As already noted, revenue is income from the sale of products, and sub-costs are understood as the costs of the company for the production and sale of products. The difference between them is profit.
There are two interpretations of costs, which are called accounting and economic.
Accounting costs are the explicit costs associated with paying for resources that do not belong to the enterprise itself, and are taken into account when calculating its remaining profit. These include:
Depreciation of fixed assets:
Costs of raw materials, components, energy;
wages of workers and employees;
rent payments;
payment for services of third parties;
tax payments;
payment of interest on loans.
The difference between revenue and accounting costs forms accounting (net economic) profit. The term "accounting" means accounting costs and should not be interpreted as costs calculated according to accounting rules. Accounting costs are sometimes called external (explicit cost), as they express the cost of resources that are owned by others.
For a comparative assessment of different investment options, in addition to accounting (explicit) costs, it is also necessary to take into account implicit costs - the costs of lost profits. Suppose that an entrepreneur who has invested in the business a capital of 100 monetary units, completely consumed during the year, produced and sold products for 110 monetary units by the end of this year, while receiving 10 units of accounting profit. The return on his capital was 10%. Was the business development option he chose economically justified if the annual interest rate paid by the bank on deposits was 15%? Obviously not. The chosen investment option brought him a loss of 5 monetary units compared to a bank deposit. This example shows that the cost of lost profits, equal in magnitude to the income from the best of the other business development options, should be considered as implicit costs. They can be called internal (implicit cost), as they show the hidden cost of resources owned by the firm itself. As part of implicit costs, the rate of return (hidden interest on equity) and the rate of return (hidden wages of the entrepreneur himself).
Explicit (accounting) and implicit costs together form economic (opportunity) costs. They show the cost of all resources used by the firm - both own and borrowed. The difference between revenue and economic costs is economic profit, that is, the excess of accounting profit over the return on the best of the alternative capital investments. The fact that an enterprise receives zero economic profit does not mean that its activities are devoid of economic sense. This only indicates that its return is equal to the return on the use of capital in other options for its use.
Costs include costs associated with sunk costs - long-term investments in assets that do not have an alternative application. It is not possible to stop these costs, so they are also called sunk costs. Imagine that an entrepreneur has acquired highly specialized equipment for the production of products that have not found demand. He will not be able to use it for other purposes, it will also be difficult to sell it. Therefore, in anticipation of the emergence of demand for products, such equipment will be stored, subject to physical and moral wear and tear (amortizing). This depreciation is an example of a sunk cost.
Conclusion
Opportunity cost is an economic term that refers to the loss of profit (profit) as a result of choosing one of the alternative options for using resources. The opportunity cost is the opportunity cost.
A simple example is given by the well-known anecdote about a tailor who dreamed of becoming a king and at the same time "would be a little richer, because he would sew a little more." However, since it is impossible to be a king and a tailor at the same time, the profits from the tailoring business will be lost. They should be considered lost profits when ascending the throne. If you remain a tailor, then the income from the royal office will be lost, which will be the opportunity cost of this choice.
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Bolshakov. M .: "Prospect", 2005
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5. Modern economy. Public training course. Rostov-on-Don.
opportunity cost- cost of lost profits or costs of alternative opportunities - an economic term denoting lost profits (in a particular case - profit, income) as a result of choosing one of the alternative options for using resources and, thereby, rejecting other opportunities. The value of the cost of lost profits is related to the utility of the most valuable of the alternatives, which turned out to be unrealized. Opportunity costs are characterized by inseparability from decision-making (actions), subjectivity, expectation at the time of the action.
Opportunity costs are not expenses in the accounting sense, they are just an economic construct for accounting for lost alternatives.
A simple example is given by the well-known anecdote about a tailor who dreamed of becoming an English king and at the same time "would be a little richer, because he would sew a little more." However, since it is impossible to be a king and a tailor at the same time, the profits from the tailoring business will be lost. They should be considered the cost of a missed opportunity when ascending the throne. If you remain a tailor, then the income from the royal position will be lost, which will be the cost of a missed opportunity in this case.
Explicit costs- these are opportunity costs that take the form of direct (cash) payments for factors of production. These are such as: payment of wages, interest to the bank, fees to managers, payment to providers of financial and other services, payment of transportation costs and much more. But the costs are not limited to the explicit costs incurred by the enterprise. There are also implicit (implicit) costs. These include the opportunity costs of resources directly from the owners of the enterprise. They are not fixed in contracts and therefore remain under-received in material form. So, for example, steel used to make weapons cannot be used to make cars. Usually enterprises do not reflect implicit costs in the financial statements, but this does not make them any less.
The idea of F. Wieser's opportunity costs
The idea of opportunity cost belongs to Friedrich Wieser, who in 1879 identified it as the idea of using limited resources and initiated a critique of the cost concept contained in labor theory cost.
The essence of F. Wieser's idea of opportunity costs is that the real cost of any produced good is the lost utility of other goods that could be produced with the help of resources used for already released goods. In this sense, the cost of producing any good is the potential loss of other, unreleased useful goods. F. Vizer. Determined the value of resource costs in terms of the maximum possible return on production. If too much is produced in one direction, less can be produced in another, and this will be felt more strongly than the gain from overproduction. Satisfying needs with an increasing output of some commodities and refusing an additional quantity of other commodities, one has to pay for the choice made a correspondingly increasing price, expressed in terms of these non-produced commodities. This is the meaning of the opportunity cost, known as Wieser's law.
Nobel laureate in the field modern economy V.V. Leontiev proposed an interpretation of Wieser's law in terms of the relative economic efficiency allocation of limited resources. It is embodied in his scientific and practical idea, which is the basis of the economic model "costs - output". Leontiev notes that the size and distribution of any mass of products, which seems to be the most effective for achieving a given economic goal, may turn out to be completely insufficient from the point of view of another goal.
The question of the economic goal, of what, how and for whom to produce, acquires practical meaning in terms of the rights and responsibility for choosing one or another alternative, which determined the proportions and directions for the distribution of limited resources. The right to choose a priority among alternatives is at the same time the obligation to compensate for the opportunity costs, to pay that increasing price for the diversion of resources to some priorities and the rejection of others.
The process of making a managerial decision involves comparing several alternative options with each other in order to choose the best one. The indicators compared in this case can be divided into two groups: the first remain unchanged for all alternative options, the second vary depending on the decision made. It is advisable to compare only the indicators of the second group. These costs, which distinguish one alternative from another, are called relevant. Only they are taken into account when making decisions.
Under control control system should have an impact on the control object. The actual cash flows that are reflected in the accounting of the enterprise act as a result of previously adopted management decisions. Information about these threads is an element feedback between the subject and the object of control. It has significant value for substantiating management decisions, however, the result of these decisions will be a change not in today's cash flows, but in future ones. To assess the financial and economic efficiency of the managerial decisions made, it is necessary to compare future cash inflows with future outflows Money conditioned by the adoption and implementation of these decisions.
For example, in order to make a decision on the release of a new type of product, it is necessary to calculate the amount of costs that the company will incur in connection with the production and sale of a new product, and compare this value with the expected income from its sale. At first glance, it may seem quite natural to use for these purposes the calculation of the full cost of one product, and, multiplying its amount by the planned sales volume, get the total cost of new products. But this approach overlooks the fact that a significant part of total costs is related to cash flows that took place in the past, even before the decision was made. Implementation of the decision will have no impact on the related cash flows in the future. If it is planned to use the stocks of materials already available at the enterprise for the production of a new product, and their quantity is sufficient to cover the entire planned need and no new purchases of these materials are expected, then it is necessary to determine how the costs of purchasing these materials are related to the release of a new product, whether it will reduce the value of these costs, the refusal to produce it, as well as what real cash outflows the enterprise will incur, using these materials in the process of implementing this management decision. Lytnev O.A. Fundamentals of financial management. Part. I: Textbook / Kaliningrad University. - Kaliningrad, 2000.
It can be argued that the material costs for the production of new products for the enterprise will be equal to the amount that it could earn by selling the stock of materials, since the enterprise has no other alternative to using them. More general definition economic costs (opportunity costs) refers to them as payments that the firm is obliged to make, or the income that the firm is obliged to provide to the supplier of resources in order to divert these resources from use in alternative industries. In this example, the release of a new product will be appropriate for the enterprise if the price offered by the buyer for it covers the opportunity costs of both raw materials and materials, as well as all other resources spent on the production of the product.
The make-it-or-buy decision is needed to explore ways best use available production capacity. Solutions could be:
1. Keeping production facilities free;
2. Transition to the purchase of components and the lease of unused funds;
3. Purchase of components and transfer of free capacities to the production of other products.
Produce in-house or acquire from outside is a strategic decision task related to long-term optimization production program. This decision is complex and must be carefully considered and justified. It should be evaluated not only from an economic, but also from a technological, qualitative, and organizational standpoint. At the same time, many conditions must be taken into account: the degree of capacity utilization, the quality of products and services, the creation or reduction of jobs, fluctuations in demand, and so on.
If there is free production capacity, buying on the side is more profitable if the total cost of acquiring is lower than variable costs own production.
If a own production involves the expansion of production capacity, it can be opened only if demand is stable and will grow in the future. Otherwise, when the market demand falls, the capacities become redundant with all the ensuing consequences.
When making this type of decision, there are qualitative relevant factors (important in decision making):
supplier reliability;
supplier quality control;
relationship between employees and administration in the supplier's company;
supplier price stability;
Internal:
capacity ownership;
technological changes.
Another type of similar decision, but in reverse, is to sell or process further, which is associated with the possibility of selling products at a certain stage of production or continuing processing in order to obtain additional income.
Orientation to the cash flows that are generated by management decisions, allows you to define opportunity costs as the amount of cash outflow that will occur as a result of the decision. The decision to launch a new product in production entails a loss of revenue from the sale of materials available at the enterprise. The cost of these materials at the prices of their possible implementation will be the amount material costs, which is taken into account when justifying the corresponding decision.
When planning its activities, the enterprise must form such a portfolio of orders so that their totality covers all fixed costs and ensures profit. If this cannot be achieved, then it is necessary to reduce fixed costs that are not directly related to the production and commercial activities of the enterprise. It cannot afford to invest its financial resources into capacity development that does not bring real returns. In any case, we are talking about qualitatively different decisions that have nothing to do with the decision to fulfill a specific order. If the enterprise has a choice, then, of course, it should prefer a more profitable option that provides maximum coverage. fixed costs. But the lack of choice cannot be a reason for not producing products whose price is higher than their opportunity cost.
By refusing to produce products that fully cover their opportunity costs in the hope of obtaining better orders that pay for the full cost of each product, the company is missing out on real cash inflows, hoping for expected higher cash inflows in the future. Such behavior is contraindicated in the conduct of business. Business owners (investors) pay their managers the only service - the real increase in invested capital. The manager should not turn down the opportunity to secure at least a minimal increase in capital if he does not have a real alternative opportunity for a more profitable use of the assets of the enterprise.
The following forms of practical manifestation of the concept of opportunity costs can be distinguished:
When justifying financial decisions, one should focus primarily on the cash flows that are generated by these decisions. Those and only those cash flows that are directly related to this management decision should be taken into account. Receipts and expenditures of funds, regardless of the time of their occurrence, which are not related to the decision being made, should not be taken into account. In other words, there are incremental cash flows, and the opportunity costs considered in it are marginal. If, as a result of making a decision on the release of new products, it is necessary to hire additional workers, then the marginal cost of maintaining new employees should be included in the cost of the product being mastered, while the cost of maintaining the same size is not relevant to this decision and cannot be included in the opportunity cost.
The decision taken cannot affect the expenses already incurred or the income received earlier. Therefore, justifying this decision, it is necessary to take into account only future cash flows. All past payments and receipts, including the cost of purchasing equipment, are of a historical nature, they can no longer be avoided or prevented.
Projects that generate cash inflows whose present value exceeds the opportunity cost associated with them increase the value of the enterprise. Increasing the capital of owners is the main goal of any enterprise and its managers. It can be said that such an abstract concept of "opportunity costs" gives the manager a powerful, fairly simple, understandable and very practical tool for monitoring the effectiveness of his work: by implementing decisions and projects, cash inflows for which exceed cash outflows, he contributes to the growth of the value of the enterprise, thereby performs its functions in the most appropriate way. This can be formulated somewhat differently: the enterprise should invest only in such projects, the net present value of which has a positive value. The task of the manager is to ensure the selection of just such projects and solutions. Lytnev O.A. Fundamentals of financial management. Part. I: Textbook / Kaliningrad University. - Kaliningrad, 2000.
The application of the concept of opportunity costs poses serious challenges for the management information subsystem. It is obvious that the data of traditional accounting alone is not enough in this case. There is a need to create an accounting system focused on a more complete and accurate identification of opportunity costs - systems management accounting. The cornerstone of such a system is the division of all expenses of the enterprise into conditionally fixed and variable parts in relation to the volume of output (sales) of products. Planning and accounting for costs in this context allows you to more closely link them with the consequences of specific management decisions, to exclude the possibility of "overlapping" on financial results of this decision, the influence of factors not related to it (for example, general factory overheads). Another distinguishing feature of such systems is the wide coverage of enterprise costs by rationing. This allows you to more accurately predict future cash inflows and outflows. The third feature of management accounting systems is the personification of information, that is, the linking of accounting objects with the areas of responsibility of specific managers, which makes it possible to even more clearly delineate the costs that depend on specific decisions from all other costs that are not related to it.
The listed features are reflected in such accounting systems as the standard method of accounting for production costs (standard-cost system), accounting for variable costs (direct costing), accounting for cost centers, as well as profit centers and responsibility centers.
On the Russian enterprises all these systems take root rather slowly, despite the fact that the introduction of the standard method of cost accounting has been going on for quite a long time. It seems that one of the reasons for this situation is the underestimation by the management of enterprises of managerial and financial functions these methods. It is still believed that they are just varieties of general accounting and the solution of emerging issues is given to the accounting personnel of enterprises. But the accounting workers face a completely different task - the timely and reliable determination of the total cost of costs, for which traditional calculation methods are quite sufficient. For ordinary accounting, the division of costs into variable and fixed parts is much less important than dividing them into direct and indirect costs. Solving fundamentally new in comparison with financial management tasks, the accountant differently perceives the task assigned to him. For him new method accounting is, first of all, a different way of distributing indirect costs between products (or refusing to do so in the case of the direct costing method). And since the introduction of any new method is associated with additional costs, not seeing a significant benefit from such a replacement, the counting worker subconsciously opposes changes that can bring him nothing but additional inconvenience and unnecessary work.
The enterprise is interested in creating a management accounting system that will be focused on control opportunity cost. For a number of properties, this system should differ significantly from traditional accounting.
On the example of opportunity costs, it becomes obvious the influence that can (and should) have at first glance the most abstract provisions. economic theory on the practice of specific enterprises. In the end, the enterprise will suffer quite tangible, real financial losses due to the action of abstract categories, the existence of which the heads of analytical departments did not know or simply did not want to know.
In many cases, opportunity costs are not measurable at all or are estimated very roughly due to the need to take into account great amount losses and gains as a result of choosing one or another variant of behavior. We present some of these cases. Choosing one strategy of functioning and development, the enterprise loses the opportunity to develop in another direction; the country chooses one direction of socio-economic development, while sacrificing another. In both cases, the alternatives available to the enterprise and the state are very difficult to compare due to their heterogeneity and the impossibility of reducing to a common denominator. It is even more difficult to make a cost, monetary assessment of alternatives when it is necessary to take into account the impact of one or another alternative decision on social welfare. Paliy VF Management accounting of costs and income with elements of financial accounting: Textbook. - M.: Infra-M, 2008..
In the practical application of the concept of opportunity cost, an imputation procedure is used. The concept of "imputation", or attribution (imputation), was one of the first to use the Austrian scientists K. Menger and F. Wieser. It means the procedure for linking certain actions of an economic entity with the benefits that it could receive if it took other actions. To implement the imputation procedure, it is necessary to bring costs and benefits to a comparable form. If the benefit is fixed in the form of some goal, then only the costs are compared. For example, you can get to work by trolleybus or fixed-route taxi. AT this case when evaluating alternatives, the time and cost of commuting to work are compared. In other cases, with cost stability (certain budgetary constraints), benefits and results are compared.
It should be noted that when comparing alternatives, in some cases, incremental cost-benefit ratios (additional costs are compared with additional benefits) should be used instead of averages. In medicine, one type of intervention must be compared not only with other types of intervention, but also with non-intervention.
Difficulties arise when using the imputation procedure. The main obstacle is that it is far from always possible to reduce to a common denominator all the losses incurred by the subject when making this or that decision. Ivashkevich V.B. Accounting management accounting: a textbook for universities. -- M.: Economist, 2006.
It is believed that opportunity costs may be those arising from not using the best available opportunity. But it may not be the optimal, best opportunity that is lost, but, say, the so-called second best, third, etc. Having chosen the best option, we lose the opportunities associated with the use of non-optimal options.
Another problem with assessing lost opportunities is its subjective nature. Subjective in some cases are the ranking of alternatives according to the degree of their attractiveness; the choice of costs and benefits (effects), which are taken into account when comparing various options for economic actions, the use of resources.
The processes concerning alternative estimates, as a rule, affect the interests of different economic actors. An increase in the opportunity price of a resource is beneficial for its sellers and disadvantageous for its buyers. The use of a resource in one direction and non-use in another may be in the interests of one group (individual) and not in the interests of another group (individual).
In addition, the decision to choose from several alternatives in some cases is made by a group of people (in economic policy, at the enterprise). Therefore, the problem arises of assessing the costs of lost opportunities for this group and for each of its members individually. The owner of a large stake in an enterprise can block an alternative that, according to him, entails high opportunity costs for the enterprise as a whole, for all shareholders, but in fact only for him. In the future, the subjective nature of the costs of lost opportunities may become the subject of joint research by representatives of the economic, psychological, and sociological sciences.
Given the above and recognizing the difficulty of assessing alternative costs, we can propose an algorithm for estimating the opportunity costs of one of the key economic entities - the enterprise: Trubochkina M.I. Enterprise cost management: tutorial. - M.: Infra-M, 2008.
1) determination of the non-alternative part of the costs of the enterprise (administrative and management expenses, insurance payments, etc.) and the alternative (part of the cost of labor, the purchase of materials, etc.);
2) promotion of alternatives within the alternative part of the costs;
3) comparison of the discounted flows of "expenses-incomes" for each alternative, placing them according to the level of profitability, the resulting effect, etc.;
4) the implementation of the imputation operation and the assessment of losses when choosing a non-optimal alternative.
Thus, the abstract concept of "opportunity costs" gives the manager a powerful, fairly simple, understandable and very practical tool for monitoring the effectiveness of his work: by implementing decisions and projects, the cash inflows for which exceed the cash outflows, he contributes to the growth of the value of the enterprise, thereby properly way it performs its functions. In this regard, there is a need to create an accounting system focused on a more complete and accurate identification of opportunity costs - a management accounting system.
opportunity cost resource economic
A term denoting lost profits (in a particular case, profit, income) as a result of choosing one of the alternative options for using resources and, thereby, refusing other opportunities. The amount of lost profit is determined by the utility of the most valuable of the discarded alternatives. Opportunity costs are an inseparable part of any decision making. The term was introduced by the Austrian economist Friedrich von Wieser in his monograph The Theory of Social Economy in 1914.
The theory of opportunity cost is described in the monograph "The Theory of the Social Economy" in 1914. According to her:
The contribution of von Wieser's opportunity cost theory to economics is that it is the first description of the principles of efficient production.
Opportunity costs are not expenses in the accounting sense, they are just an economic construct for accounting for lost alternatives.
Example
If there are two investment options, A and B, and the options are mutually exclusive, then when assessing the profitability of option A, it is necessary to take into account the lost income from not accepting option B as the cost of a missed opportunity, and vice versa.
A simple example is given by the well-known anecdote about a tailor who dreamed of becoming a king and at the same time "would be a little richer, because he would sew a little more." However, since being a king and a tailor simultaneously impossible, then the profits from the tailoring business will be lost. This should be considered lost profit upon ascension to the throne. If you remain a tailor, then the income from the royal position will be lost, which will be opportunity cost this choice.
Notes
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See what "opportunity cost" is in other dictionaries:
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Books
- The Economic Way of Thinking, Heine P., Bouttke P., Prychitko D. The Economic Way of Thinking is one of the world's most popular economics courses. 15 of the book describes not only the basic principles of micro- and macroeconomic analysis, but also ...