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Opportunity Cost

function of the business rather than to marketing or their salary on a nice house, an expensive vacation, or on
finance. This situation is also true in service firms. a yacht, but they probably cannot afford all three. They
The organization for manufacturing depends on the must make choices with their limited resources of money.
complexity of the products manufactured and the size of In making choices for using limited resources, it is rea-
the company. In a large company the manufacturing sonable to evaluate the costs and benefits of all possible
organization has divisions such as engineering, production options. For instance, suppose one has been trying to
control, inspection, and purchasing. The success of a decide how to spend the next few years of one’s life. He or
product depends on the proper development and manage- she has narrowed the options down to two: (1) working at
ment of the product. a full-time job, or (2) becoming a full-time student. Going
to school will cost approximately $12,000 per year in
CONCLUSION tuition, books, and room and board at the local state uni-
versity for the next four years. In addition, he or she will
Management is universal. When more than one person is
concerned with a goal, there is need for a process by which forego the salary of a full-time job, which is $24,000 per
this goal can be attained. Management is active in every year. This makes the total cost of going to school $36,000
per year. In return he or she gets the pleasure, social inter-
part of business and at every level. Its functions are per-
action, and personal fulfillment associated with gaining an
formed in every department and in every function of the
education, as well as the expectation of an increase in salary
business. The practice of operations management is a con-
through the remainder of his or her work life.
tinuous process of problem solving and decision making.
The functions of management are based on the ability to The question that must be answer is, “Do the bene-
make decisions and then to carry out all the implications fits of education outweigh the costs?” If they do, school
of those decisions. should be selected. If the costs are greater than the bene-
fits, the full-time job should be kept.
SEE ALSO Productivity
An “opportunity cost” is the value of the next-best
alternative. That is, it is the value of the option that was
BIBLIOGRAPHY not selected. In the example, if the person had chosen to
Kusiak, Andrew (1999). Engineering Design: Products, Processes, keep the job, then the opportunity cost is the benefit of
and Systems. San Diego: Academic Press.
going to school, including the intangible benefits of pleas-
Moody, Patricia E. (1999). The Technology Machine: How Manu- ure, social interaction, and personal fulfillment as well as
facturing Will Work in the Year 2020. New York: Free Press.
the tangible benefit of an increased future salary for the
Williams, Blair R. (1996). Manufacturing for Survival: The How- person’s remaining working life. If the person had chosen
to Guide for Practitioners and Managers. Reading, MA: Addi-
son-Wesley. to go to school, then the opportunity cost is the $24,000
per year that would have been earned at the full-time job.
One way of visualizing this concept is through the
Janel Kupferschmid
use of a production possibilities curve—a graph that
relates the tradeoff between two possible choices, or some
combination of the possibilities. Consider a very simple
possible economy for a country. This country can produce
OPPORTUNITY COST two goods: guns (i.e., defense) or butter (i.e., consumer

One of the lamentable facts of life is that nobody can have goods). If this country has historically used all of its
everything that he or she wants. This is due, in part, to resources to produce guns then it may be willing to con-
scarce resources. Whether a teenager with a part-time job sider allocating some of its resources to the production of
or a wealthy businessperson, no single person owns all of butter. Initially, the resources that are least effective in pro-
the money in the world. Furthermore, there are only ducing guns (e.g., farmland) will be reallocated to the pro-
twenty-four hours in a day, and seven days in a week. duction of butter. Thus, the country does not forfeit many
Time and money are only two of the many resources that guns to produce a relatively large amount of butter. How-
are scarce in day-to-day living. ever, as the country reallocates more resources to the pro-
Unfortunately, because of these limits, individuals duction of butter it is decreasingly productive. At the
have to make choices in using scarce resources. One can extreme, when the country gives up the last of its produc-
use his or her time to work, play, sleep, or pursue other tion of guns, the resource is very good for producing guns
options or, one can select some combination of possible and not very useful in the production of butter (e.g., a
activities. People cannot spend twenty-four hours a day high-tech armaments production facility). Figure 1
working, twenty-four hours a day playing, and twenty- demonstrates this situation graphically in showing an
four hours a day sleeping. People can choose to spend example of the production possibilities curve.

ENCYCLOPEDIA OF BUSINESS AND FINANCE, SECOND EDITION 563