This is not to say that economics has all the solutions. It would be, therefore, profitable to shift labour from low marginal value activity to high marginal value activity, thus increasing the total value of all products taken together. That is the expenditure to national fund for buying armor has cost the nation of losing an opportunity of buying more butter. Sacrifice of alternatives is involved when carrying out a decision requires using a resource that is limited in supply with the firm. There are six basic principles of managerial economics. Thus we find that opportunity cost of anything is the next best alternative that could be produced instead by the same factors or by an equivalent group of factors, costing the same amount of money. This appears similar to the saying that “a bird in hand is more worth than two in the bush.” This judgment is made not on account of the uncertainty surrounding the future or the risk of inflation. Thus, it is clear that opportunity costs require the ascertaining of sacrifices. If a decision involves no sacrifice, its opportunity cost is nil. It was Marshall who introduced time element in economic theory. The difference between actual and opportunity costs is called economic rent or economic rent or economic profit. We cannot have everything we want. Economic theory provides a number of concepts and analytical tools which can be of considerable and immense help to a manager in taking many decisions and business planning. Equi-Marginal Concept: One of the widest known principles of economics is the equi-marginal … It is simply that in the intervening period a sum of money can earn a return which is ruled out if the same sum is available only at the end of the period. Marginal revenue is change in total revenue per unit change in output sold. 4000 = Rs. We are, therefore, forced to make a choice. The principle states that an input should be allocated so that value added by the last unit is the same in all cases. In order to produce a good the producer has to employ various factors of production and have to pay them sufficient prices to get their services. In other words, cost is determined by the highest-valued opportunity that must be foregone to allow current use. Secondly, in the above definition is the addition of the qualification or by an equivalent group of factors costing the same amount of money. If resource has no alternative use, then its opportunity cost is nil. This concept is an extension of the concept of time perspective. The factor must be paid atleast the price they are able to obtain in the alternative uses. The main problem in decision making is to establish the right balance between long run and short run. The concept of opportunity cost plays an important role in managerial decisions. Learn how your comment data is processed. In Managerial Economics, the opportunity cost concept is useful in decision involving a choice between different alternative courses of action. Opportunity cost of a decision is the sacrifice of alternatives required by that decision. A rational businessman will certainly buy a press machine that gives him a higher return. The two major concepts in this analysis are incremental cost and incremental revenue. 40,000 annually from the washing machine. If that machine can produce 10 units of X or 20 units of Y, the opportunity cost of 1 X is equal to 2 Y. 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The mathematical technique for adjusting for the time value of money and computing present value is called ‘discounting’. The economic concepts of the long run and the short run have become part of everyday language. The decision of a firm to change the price would depend upon the resulting impact/change in marginal revenue and marginal cost. Marginal analysis implies judging the impact of a unit change in one variable on … In everyday life, we apply the notion of opportunity cost even if we are unable to articulate its significance. A decision may be made on the basis of short run considerations, but may as time elapses have long run repercussions which make it more or less profitable than it at first appeared. The opportunity cost of the time as an entrepreneur devotes to his own business is equal to the salary he could earn by seeking employment. So long as economic profit is above zero, it is rational to invest resources in press machine. Opportunity cost, therefore, represents the benefits or revenue forgone by pursuing one course of action rather than another. To take an example, a farmer who is producing wheat can also produce potatoes with the same factors. The economic significance of opportunity cost is as follows: (i) It helps in determining relative prices of different goods. (i) It increases revenue more than costs. The opportunity cost principle may be stated as under: “The cost involved in any decision consists of the sacrifices of alternatives required by that decision. If there are no sacrifices, there is no cost.” Thus in macro sense, the opportunity cost of more guns in an economy is less butter. Opportunity Cost Principle: This principle is of immense use in decision-making. In fact, actual problem solving in business has found that there exists a wide disparity between economic theory of the firm and actual observed practice. The opportunity costs or alternative costs are the return from the second best use of the firm’s resources which the firm forgoes in order to avail itself of the return from the best use of the resources. Marginal Principle. But, in the process of earning Rs. 40,000 is his opportunity cost or alternative cost. Everyone knows that a rupee today is worth more than a rupee will be two years from now. While the term opportunity cost has its roots in economics, it’s also a very important concept in the investment world. Managerial Economics is both conceptual and metrical. 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