Cost Contd The

Cost Contd The

Cost (cont�d) The concept of opportunity cost makes possible a more rational choice between alternatives than the everyday notion of costs as the money outlay necessary to buy something. The reason why is not readily apparent, for if cost to a business means the money laid out on the hire of factors, if this reflects the prices that have to be paid to attract the factors from alternative occupations, and if those prices in turn reflect the value of the alternative goods that the factors were capable of producing, then money costs and prices would correctly reflect opportunity cost. In real life this equivalence is distorted for a number of reasons:

First, because money prices determined competitively may be altered by individuals or groups powerful enough to 'rig' markets and prices in their own interests: if factors of production are thus prevented from moving into these privileged lines of activity their money rewards (prices) are artificially limited and no longer reflect the value to consumers of the alternatives they could produce.

Secondly, because the costs or prices on which individuals base their decisions may not correctly reflect the alternatives sacrificed by the community as a whole. Economists have long argued that, for example, a smoky factory may involve widespread sacrifice of alter-natives by imposing additional cleaning and renewal costs on the community at large; these are not normally considered as part of the costs of the firm concerned, although some economists argue that they could be taken into account by those who move near smoky factories or in areas where smoky factories could be built.

Thirdly, because alternatives forgone are not always clear-cut. If production were everywhere organized so that factors of production could always be hired in 'penny numbers', and if the factors of production were always readily and immediately adaptable to alternative uses, there would be no problem. But modern production processes are complex, using large amounts of highly specialized and durable capital equipment which (a) can often be bought only in expensive lumps and (b) once acquired has no alternative use (except perhaps to another producer in the same line of production). A firm's accountant allocates the money costs of durable equipment to current output as overheads in the form of depreciation charges. But in terms of opportunity cost this practice has no significance for current decisions on what or how much output to produce. In the past the price paid for equipment may at that time have reflected the alternatives forgone in producing it; but this 'historic cost is irrelevant for two reasons. First, since 'bygones are bygones', the recovery of historic cost has no economic meaning. The only question of economic relevance is, 'Will the value of the output of equipment during its life be sufficient to cover its current replacement costs?' Secondly, if it had no alternative use at all, and was wholly un-adaptable to any other line of production, then its opportunity cost would be zero; and whether or not it was currently 'earning its keep' (other than covering current maintenance charges) would not matter. It might just as well be used as not. The question is therefore relevant only to decisions about renewal or replacement.

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