Opportunity Cost is the income foregone which a businessman could expect from the second best alternative use of his resources. For example if an entrepreneur uses his capital in his own business he foregoes interest which he might earn by purchasing debentures of other companies or by depositing his money with joint stock companies for a period. Further more if an entrepreneur uses his labour in his own business he foregoes his income (salary) which he might have earned by working as a manager in another firm.
Similarly by using productive assets (Land & Building) in his own business he sacrifices his market rent. These foregone incomes- interest, salary and rent are called opportunity Costs or Transfer Costs.
Also opportunity cost in called Implicit cost or Imputed Cost Accounting Profit = Total Revenue – Explicit Cost
|or A.F. = T.R – (W||+ R||+ I +||M)|
|Pure Profit/ Economic Profit|
|= Total Revenue –||(Explicit Cost + Implicit Cost)|
If a machine can produce either ‘X’ or ‘Y’ the opportunity cost of producing a given quantity of ‘X’ is therefore the quantity of ‘Y’ which it would have produced. If that machine can produce 10 units of X or 20 units of Y, the opportunity cost of IX is 2Y.
In macrosense, the opportunity cost of more guns in an economy is less butter. Continued diversion of funds to defense spending amounts to a heavy tax on alternative spending on growth & development.