a) Explain how opportunity cost differs from accounting cost. (b) Does every eco
ID: 1216193 • Letter: A
Question
a) Explain how opportunity cost differs from accounting cost. (b) Does every economic choice in business have an opportunity cost? Explain. (c) Provide an example of a business practice with an opportunity cost that is different than its accounting cost. (d) Why do businesses use accounting costs, rather than opportunity costs, in recording their business expenses? (e) Could the opportunity cost of a given business decision be different for different companies and/or be different for the same company at different times? Explain.
Explanation / Answer
(a) Accounting cost is the actual costs incurred in course of running a business, for example materials, labor cost and overhead expenses. But opportunity cost (OC) is an implicit cost which is the benefit foregone by choosing one alternative over another. For example, if a person starts her own business by refusing to accept a job that would be paying her $40,000 a year, the annual opportunity cost for that business would be $40,000 which is not included within its accounting cost.
(b) Every choice has an opportunity cost. This is because, each business choice is taken by foregoing another alternative choice, and the benefit that could arise from the foregone choice itself is the opportunity cost of the preferred choice.
(c) Consider a firm that can produce either product A or product B. Production of B will fetch a net profit of $10,000 a month. If the firm decides to produce product A and not B, then the opportunity cost is $10,000, which will not be included in the accounting cost.
(d) Opportunity costs are difficult to measure and their probability of occurence may be subjective and/or improbable. But explicit (accounting) costs are actual costs that can be measured and are being actually incurred by the business. Therefore, businesses use accounting cots.
Note: First 4 sub-parts are answered.
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