Measurement of Opportunity Cost

In this article we will discuss about the measurement of opportunity cost. The reader will also be able to learn about whether opportunity cost can ever be zero or not.

In truth, the central problem faced by every society is the allocation of scarce resources to satisfy as many wants as possible.

The problem arises because of three characteristics of a modern economic society:

1. Unlimited human wants:

This is the starting point of any economic analysis.

2. Limited capacity to satisfy the needs and wants:

Resources of land, labour and capital available to produce various goods and services to satisfy human wants are scarce, i.e., X.

3. Alternative uses of resources:

Resources are scarce but resources have alternative uses. For example, the amount of land available in a particular locality may be used to grow wheat or to set up a factory, or to construct ownership flats. Likewise, labour can be employed on farm land, in a modern factory, or in construction industry and so on.

The first two characteristics give rise to the basic economic problem faced by any society, viz., the problem of scarcity. The problem exists simply because no society is having sufficient resources to satisfy all the needs and desires of people (for various goods and services).

The third characteristic, in conjunction with the problem of scarcity, gives rise to the basic need for choice. To get something we have to give up something else. There is no such thing as free lunch in economics.

Society’s choice problem may be presented as follows:

How to allocate limited resources among competing uses? For instance, how many workers should be employed in growing wheat, how many to produce motor cars, how many to carry passenger baggage’s in railway stations, how many in factory work and how many in road construction?

Thus, it follows that the central economic problem faced by any society is the allocation of scarce resources among competing uses for the satisfac­tion of (unlimited) human wants.

Opportunity Cost:

Since a sacrifice is always involved in choosing to use scarce resources to produce one commodity (say jute) rather than another (say, wheat), the concept of opportunity cost is one of the key concepts of modern economics. We use the concept to highlight one basic fact of our lives: in order to get something we have to give something else or the production of one com­modity is always at the expense of the other.

For example, certain amounts of land, labour, power and capital are required to produce, say, 25 pocket calculators. The same amount of resources could alternatively be used to produce one mini-computer. Thus, the sacrifice made in producing the mini-computer is 25 pocket calculators.

Or, in other words, the opportunity cost of 1 mini-computer is 25 calculators. Or, the opportunity cost of a calculator is 1/25 of a mini-computer. Thus, the amount of the other commodity sacrificed to produce (get) one extra unit of a particular commodity is its opportunity cost.

Let us consider a second example. Suppose, a farmer is having a small plot of land which is suitable for growing both wheat and jute. At present the farmer is growing only wheat. Now, jute can be grown only if the production of wheat is permitted to fall.

It is so because the farmer has limited stock of land that is already fully used. So, the decision to grow some jute implies a decision to grow less of something else (wheat, in our exam­ple). Thus, in reduction in the output of something else can be treated as the cost of jute.

Economists often make use of the concept of opportunity cost to illustrate the basic idea of choice. Opportunity cost measures the cost of something that one acquires, measured in terms of the sacrifice of the next best alternative. Thus, in our previous example, the opportunity cost of jute is measured in terms of the extra wheat that the farmer could produce instead. In reality the opportunity cost of a quintal of wheat might be 1/2 of a ton of raw jute.

Measuring Opportunity Cost:

There are two points to note about opportunity cost:

The first point is that, it is always positive because it usually involves sacrificing (or giving up) some positive amount of one commodity in order to get one extra unit of another.

Secondly, opportunity cost is measured in numbers and not in terms of money. In fact, economists often distinguish between real opportunity cost and money cost. Suppose, you ask what is the cost on one digital wrist- watch. Someone says that it is Rs. 450. But, this statement hardly indicates anything.

You have to know what else you could buy by spending the same amount of money. Here costs are, no doubt, expressed in terms of money. This is meaningful because we know the market price of other commodities (which could be purchased with Rs. 450).

The knowledge about market prices enables us to make real opportunity cost comparisons. Thus, suppose the price of a motor cycle is Rs. 15,000 and that of a car is Rs. 1, 50,000. Here, the opportunity cost of the car is 10 motor cycles or the opportunity cost of a motor cycle is 1/20 of a car.

Can opportunity cost ever become zero?

In most real life situations opportunity cost is positive. It is because to get one extra unit of a commodity we have to sacrifice some positive amount of some other commodity. However, there are certain situations where opportunity cost may be zero.

Important exceptions are shown below:

1. Free Goods:

Free goods like air, water and sunshine have zero oppor­tunity cost because their total supply exceeds total demand. Therefore, no sacrifice has to be made to obtain them.

In other words, no opportunity cost is involved in their use. The same thing can be said about sand in a desert or fruit in an unreserved forest (where fruit is for picking). Fruit grows automatically is such forests and not cultivated on land that could be used for other purposes (such as growing wheat). Its production by ‘nature’ implies no sacrifice of alternative crops. (However, actual picking may involve opportunity cost: if you spend time to pick fruit, you cannot watch a football match).

2. Single-Use Factors:

If a particular resource has alternative uses, positive opportunity cost occurs. But, if no such alternative exists, no opportunity cost is involved in keeping it idle. For example, the opportunity cost of a machine that is lying idle for the last two years is zero. Similarly, the opportunity cost of an unused factory space is zero. There is no other use to which it could be put.

Another example of such single-use factors is a coal mine. It can produce coal and nothing else. If coal is not produced it will remain idle. Such resources like a coal mine or a machine or even a road are said to be product- specific inasmuch as they are specific to the production of one commodity or the generation of one service and nothing else. So, they have no opportunity cost.

General Unemployment:

In developing countries like India, unskilled labour is a surplus resource. Such labour has no opportunity cost. So, it is said that there is the problem of surplus labour or disguised unemployment in rural areas. Most workers in rural area have only one option: to work on land. If they do not get such work they have to remain idle due to the absence of alternative employment opportunities outside agriculture.

Heavy Unemployment:

Opportunity cost is positive when producing more of good requires taking resources away from producing another good. This usually happens when the economy is operating with full capacity and when there is full employ­ment of all resources including manpower.

Suppose, an economy is oper­ating near the full employment level. Also assume that 40 workers are required to build a hospital within a month. Alternatively, the same workers can construct two school buildings within the same time period. Thus, the opportunity cost of a hospital is two school buildings.

Sometimes, however, we observe that there are unemployed resources in the economy. In such situations the opportunity cost of an idle resource may be zero. If, for example, there are idle workers, cranes, building materials and other resources required by the building trade, it may be possible to build more hospitals without reducing the number of school buildings or anything else.

Thus, an economy having unemployed resources can avoid the problem of choice. In other words, a full employment economy is always faced with the problem of choice: it must give up some units of one commodity to get more of the other.

In general, opportunity cost of a resource is zero only when there is general unemployment of resources, including manpower. If there is unem­ployment of labour, but no idle equipment, it would be possible to build more hospitals by utilising the surplus labour. Thus there would be no need to transfer workers from other uses.

But, there would be need to transfer equipment from some other use. Therefore, production of some other, commodity (in which the equipment was originally used) would fall. Thus opportunity cost is positive even when there is full employment of at least one resource which is needed to produce more of the commodity desired by the members of society. All the resources need not be fully employed for opportunity cost to be positive.

In general, opportunity cost is positive in two cases:

(1) When there is full employment of at least one resource.

(2) If the government has decided, as part of its macroeconomic policy to maintain a certain level of unemployment of resources.

In the latter case, the resources required to produce more of the same commodity will have to be diverted from other activities. In such a situation opportunity cost would be positive in spite of the existence of unemployed resources.