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By the opportunity cost of a decision is meant the sacrifice of alternatives required by that decision. For example:
a) The opportunity cost of the funds employed in ones own business is the interest that could be earned on those funds if they have been employed in other ventures. b) The opportunity cost of using a machine to produce one product is the earnings forgone which would have been possible from other products. c) The opportunity cost of holding Rs. 1000 as cash in hand for one year is the 10% rate of interest, which would have been earned had the money been kept as fixed deposit in bank.
Its clear now that opportunity cost requires ascertainment of sacrifices. If a decision involves no sacrifices, its opportunity cost is nil. For decision making opportunity costs are the only relevant costs.
% of resources devoted to
Number
of X 0 4
production
of item X
0 20
of item Y
100 80
Qty. of Y 15 14
Row
A B C D
40
60 80 100
7
9 11 12
60
40 20 0
12
9 5 0
E
F
A production possibility curve measures the maximum combination of outputs that can be achieved from a given number of inputs. It slopes downward from left to right. The production possibility curve not only represents the opportunity cost concept, it also measures the opportunity cost.
10 9 8 7 6 .
2Y
5
4 3 2 1 0 1 2
1X
10
Any point within the production possibility curve represents inefficiency. Inefficiency getting less output from inputs which, if devoted to some other activity, would produce more output.
Any point outside the production possibility curve represents something unattainable, given present resources and technology.
10
8
Unattainable point, given available technology, resources and labor force Efficient points Inefficient point 2 4 Y C D
6
X 4
B
A
2
0
10
Incremental Principle
It is related to the marginal cost and marginal revenues. Incremental concept involves estimating the impact of decision alternatives on costs and revenue, emphasizing the changes in total cost and total revenue resulting from changes in prices, products, procedures, investments or whatever may be at stake in the decisions.
The two basic components of incremental reasoning are 1) Incremental cost 2) Incremental Revenue A manger determines the worth of an economic decision on the basis of the criterion that IR>IC.
The incremental principle may be stated as under : A decision is obviously a profitable one if a) it increases revenue more than costs b) it decreases some costs to a greater extent than it increases others c) it increases some revenues more than it decreases others and d) it reduces cost more than revenues