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Opportunity CostBy the opportunity cost of a decision is meant the sacrifice

of alternatives required by that decision. For example:a) The opportunity cost of the funds employed in ones own

business is the interest that could be earned on those funds if

they have been employed in other ventures.

b) The opportunity cost of using a machine to produce one

product is the earnings forgone which would have been possiblefrom other products.

c) The opportunity cost of holding Rs. 1000 as cash in hand for

one year is the 10% rate of interest, which would have been

earned had the money been kept as fixed deposit in bank.Its clear now that opportunity cost requires ascertainment

of sacrifices. If a decision involves no sacrifices, its

opportunity cost is nil. For decision making opportunity

costs are the only relevant costs.

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Production Possibilities Curve

A production possibilities curve is usedto illustrate opportunity cost.

The production possibilities curveshows the trade-offs among choices we

make.

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A Production Possibility Table

Aproduction possibility tablelists a

choice's opportunity costs by

summarizing what alternativeoutputs you can achieve with your

inputs.

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% of resources

devoted to

production

of item X

Number

of X

% of resources

devoted to

production

of item Y

Qty.

of Y Row

0

20

40

60

80

100

0

4

7

9

1 1

12

100

80

60

40

20

0

15

14

12

9

5

0

A

B

C

DE

F

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Aproduction possibility curve

measures the maximum combination

of outputs that can be achieved from

a given number of inputs.

It slopes downward from left to right. The production possibility curve not

only represents the opportunity cost

concept, it also measures theopportunity cost.

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The production possibility curve demonstrates

that:

There is a limit to what you can achieve,given the existing institutions,resources, and technology.

Every choice made has an opportunitycost

you can get more of something

only by giving up something else.

The production possibility curve is generally

bowed outward.

Some resources are better suited for the

production of some goods than others.

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10

9

8

6

5

4

3

2

1

0

.2Y

1X

A

X

1 2 3 4 5 6 7 8 9 10

If the slope of the production curve is -2atA, the opportunity cost

of 1Xis 2Y.

7

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Why is the production possibility curve is not a

straight line?

Theprinciple of increasing marginal

opportunity coststates that opportunity costs

increase the more you concentrate on an

activity.

In order to get more of something, one must

give up ever-increasing quantities of something

else.

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Any point within the production possibility

curve represents inefficiency.

Inefficiency

getting less outputfrom inputs which, if devoted tosome other activity, would produce

more output.

Any point outside the production possibility

curve represents something unattainable,given present resources and technology.

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X

10

8

6

4

2

02 4 6 8 10

Y

C D

A

B

Efficient

points

Inefficientpoint

Unattainable point,given available technology,resources and labor force

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Incremental Principle

It is related to the marginal cost and

marginal revenues. Incremental

concept involves estimating the impact

of decision alternatives on costs andrevenue, emphasizing the changes in

total cost and total revenue resulting

from changes in prices, products,

procedures, investments or whatever

may be at stake in the decisions.

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The two basic components of

incremental reasoning are1) Incremental cost

2) Incremental RevenueA manger determines the worth

of an economic decision on the

basis of the criterion that IR>IC.

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The incremental principle may be stated asunder :

A decision is obviously a profitable one if

a) it increases revenue more than costs

b) it decreases some costs to a greaterextent than it increases others

c) it increases some revenues more than

it decreases others andd) it reduces cost more than revenues