OPPORTUNITY
COST
Cost
should be defined in terms of the alternative use of resources. The
opportunity cost principle states that the cost of a resource to a
firm is its value as best alternative use. The valuer's and
economist's notion of cost includes the implicit costs of not
employing the resources in alternative uses. A return above the most
profitable alternative use that results from a temporary situation or
the existence of a monopoly is pure profit or economic rent.
The
opportunity cost of buying a capital investment such as a house may
be not being able to apply that cost to another investment such as
buying or expanding a business.
see
fixed costs
Opportunity
costs are that result from the taking up the alternative use of a
good, service or asset.
EXAMPLE
The
opportunity cost of a carpark is the value of that land if used for
another (highest and best) use. It may be for medium density
residential construction.
OPPORTUNITY
COST IN BENEFIT COST ANALYIS (BCA)
The use of resources (manpower, finance or land) in
one particular area will preclude their use in any other and therefore,
the basis for valuing the resources used is the opportunity cost of
committing resources that is, the value those resources would have in
the next most attractive alternative use. The adoption of this
principle reflects the fact that the economic evaluation of the public
sector project should be conducted from the perspective of society as a
whole and not from the point of view of a single agency.
Commonly the price paid for new capital, labour or
other inputs will reflect the opportunity cost of the resources. The
position may be less clear in the case of the use of existing land
owned by the agency however, the cost equivalent to its current market
value should be placed on such land as the government body usually has
the option of selling such land on the open market. This principle
applies even where the public sector may have access to an input as a
cost different to its market value.
EXAMPLE
If a government department rents office space in a
building owned by another government body, often the agreed to rent is
below the market rent. The cost to the building's owner should be the
loss in rent as it has the alternative option of letting the space to
an outside body at market rates. This principle underlines the fact
that many government buildings have alternative uses and the
opportunity cost to the government is the lost revenue by not taking up
the alternative land use.
