Opportunity Cost: Why it is so Important

1. Opportunity Cost: Why it is so Important Martha Rowland Blenman College of Business University of Michigan Dearborn December 11, 2013

2. Definition? • Formally: “The explicit cost of a resource plus the implicit cost of giving up the best alternative use” (Baye p. 5) • This follows from discussion of total costs in production and resource allocation. • From a publically owned firm’s point of view, their goal is to maximize shareholder value which implies efficient allocation of all resources.

3. From the firm’s point of view • All resources are scare. • As the firm evaluates possible projects or lines of business, understanding and estimating costs explicit & implicit are very important. • Explicit cost determination uses accounting terminology and finance theory (time value of money) in indicate added value. • Implicit cost or opportunity costs are included in this analysis and are very hard to determine.

4. Practical use of Opportunity Cost Concept! • Once students understand that their whole life is about opportunity cost: the choices they make every day, they will see the amazing contribution to thinking(not just economic thinking), this concept brings. • I believe this can be taught to very young elementary school students….I have done before.

5. Examples • Allowance: how they spend it and when • Sleep or the lack of it! • Education choices • Purchasing a car • Purchasing clothing Of course the list goes on and on.

6. References • Managerial Economics and Business Stratey, 8th edition, 2014, Michael R. Baye and Jeffry T. Prince. McGraw-Hill Irwin.

7. Contract Information • Martha Rowland Blenman University of Michigan Dearborn mrowlan@umich.edu