What is the correct calculation of opportunity cost in economics?

[Kazza_765]

Hi all,

I've just taken my first postgraduate "Managerial Economics" class (aimed at people who haven't studied economics before), and my lecturer has thrown me a curve ball with the concept of opportunity cost. Either my memory's not as good as it used to be, or his isn't.

Anyway, he gave an example problem that went like this...

Jim currently has a job that pays $70,000 per year. He is considering starting up his own company next year.

The cost of starting up his own company (non-recoverable) is $100,000. If he starts up his own business, he will also work part-time for $10,000.

What is Jim's opportunity cost for setting up his own business.

Now, it was my understanding that opportunity cost is the value of the next best alternative. This is also the definition that the lecturer used in class. So in this case, the opportunity cost would be $70,000, because that is what Jim is missing out on by setting up his business.

My lecturer said that the opportunity cost is $160,000 ($70,000 - $10,000 + $100,000), which is what I would have called the total cost, of which the opportunity cost is only one part.Am I mistaken? Is the opportunity cost actually $160,000?edit: oh, and interest rates are zero.

 

[HallsofIvy]

Given your definitions, I would say $160,000. He could be making $70,000 a year. Instead he has to pay $100,000 to start the company, while earning $10,000, a difference of 70000- 100000+ 10000= -160000.

 

[Architeuthis Dux]

Hello,

I am not an expert in economics but I can provide some insights into the concept of opportunity cost based on my understanding. Opportunity cost is indeed the value of the next best alternative that is given up in order to pursue a certain action. In this case, the next best alternative for Jim would be to continue working at his current job that pays $70,000 per year.

However, the calculation of opportunity cost can be a bit tricky and may vary depending on the perspective. Your lecturer's calculation of $160,000 takes into account the total cost of starting up the business, which includes the non-recoverable cost of $100,000 and the part-time income of $10,000 that Jim will no longer receive if he starts his own company. So, from this perspective, the opportunity cost would be the total cost that Jim would incur if he chooses to start his own business.

On the other hand, if we look at the opportunity cost from Jim's point of view, it would indeed be $70,000 as he would be giving up his current job and the associated income. So, both perspectives are correct in their own way.

I would recommend discussing this with your lecturer to understand their reasoning behind the calculation of opportunity cost in this scenario. It is also important to keep in mind that opportunity cost is not always a monetary value and can also include time, effort, and other resources that are given up in pursuit of a certain action.

I hope this helps clarify the concept of opportunity cost for you. Keep exploring and learning about economics, and don't hesitate to ask questions when something doesn't seem clear. Good luck with your studies!