Economics

Assumptions And Limitations Of Opportunity Cost In Economics

Opportunity costs : Prof. Wiser, an Austrian economist used this concept for the first time in Economics. Later on it was developed by several economists like Davenport, Knight, Wicksteed and Robbins. This concept has several names like Alternative cost, Transfer price or Transfer cost.

This concept is based on the fundamental fact that resources are scarce and ends are unlimited. It is not possible for us to produce all the commodities due to this fundamental fact. If we choose the production of more Cotton, we have to reduce the cultivation of sugarcane and paddy. Similarly, if we want to produce more tobacco, we have to reduce the Cultivation of other crops.

Opportunity cost is the cost of displaced alternative. It is defined as the amount of goods foregone in producing a commodity. If we produce 100 quintals [100KG =1 Quintal] of cotton by foregoing 120 quintals of paddy, the opportunity cost of 120 quintals of paddy is 100 quintals of cotton. Similarly, the opportunity cost of 100 quintals of cotton is equal to 120 quintals of paddy.

Opportunity cost also the retention price of factor equal to what it would have earned when employed somewhere else. For example, the cost of production of 100 quintals of cotton and that of 120 quintals of paddy are same. Then their exchange value can be decided as 120 quintals of cotton is equal to 100 quintals of paddy. To quote Adam Smith’s words ” if a hunter can bag a deer or a bear in a single day, the cost of a deer is a bear and the cost of a bear is a deer”.

Assumptions of Opportunity Costs :

The concept of opportunity costs is based on the following assumptions:

1) Factors of production are freely mobile.

2) Perfect competition prevails in the market.

3) All the units of factors of production are homogeneous.

4) There prevails full employment of resources.

5) Factors of production are not specific as they can be put to alternative uses.

Criticism or Limitations of opportunity costs:

The following are leveled against the concept of opportunity cost :

1. Opportunity costs in the case of factors of production can’t be calculated easily.

2. This concept is not useful for calculating the risks and pains undergone by the entrepreneur in production process.

3. This concept is applicable only when perfect competition prevails. But in actual practice perfect competition is a myth.

4. Factors of production are not freely mobile between different alternative employments. So opportunity cost of each factor can’t be known.

5. This concept is not applicable in the case of specific factors.

6. This concept is based on the homogeneity of factors. But all the units of factors of production are not homogeneous in reality.

7. This concept assumes that resources are constant and do not change. So it is a static concept.

8. Factors of production influenced by elements like inertia may not move from one industry to the other.

9. This concept fails to take into consideration social costs like ill-health, environmental pollution etc. arising due to the expansion of industries.

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