Applications of Opportunity Cost

The concept of opportunity cost has been widely used by modern economists in various fields. The main applications of the concept of opportunity cost are as follows –

Determination of factor prices – The factors of production need to be paid a price that is at least equal to what they command for alternative uses. If the factor price is less than factor’s opportunity cost, the factor will quit and get employed in the better-paying alternative.

Determination of economic rent – The concept of opportunity cost is widely used by modern economists in the determination of economic rent. According to them economic rent is equal to the factor’s actual earning minus its opportunity cost (or transfer earnings).

Decisions regarding consumption pattern – The concept of opportunity cost suggests that with given money income, if a consumer chooses to have more of one thing, he has to have more of one thing, he has to have less of the other. He cannot increase the consumption of all the goods simultaneously. Hence with the help of opportunity cost he decides the consumption pattern, that is, which goods should be consumed and in what quantities.

Decisions regarding production plan – With given resources and given technology if a producer decides to produce greater amount of one commodity, he has to sacrifice some amount of another commodity. Thus on the basis of opportunity costs a firm makes decisions regarding its production plan.

Decisions regarding national priorities – With given resources at its command a country has to plan the production of various commodities. The decision will depend on national priorities based on opportunity costs. If a country decides that more resources must be devoted to arms production then less will be available to produce civilian goods. In this situation a choice will have to be made between arms production and civilian goods. The concept of opportunity cost helps in making such choices.

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