Analysis of cost and its role in the decision-making process by answering the following questions:
- Citing examples, differentiate between opportunity cost, marginal cost, and relevant cost.
- Assess the relationship of marginal benefit and marginal costs. How is marginal benefit measured, and how does it relate to marginal costs?
- What other factors must managers address before making decisions? Why?
ANALYSIS OF COST IN DECISION-MAKING
Opportunity cost, marginal cost, and relevant cost
Opportunity cost is the earnings or benefits foregone as a result of a decision. An example of this is when a person decides to use his investable funds amounting to $50,000 to start a business. This amount was used to purchase machineries and equipment, lease a space, and process documents with expectations of future returns. Because of the decision to invest the $50,000 in a new business, the individual is foregoing an opportunity to earn should the same amount was invested in bonds or shares of stocks. Hence, the opportunity cost of deciding to use the $50,000 to start a new business is the earning that it should have garnered in buying bonds in the form of periodic interest income or the dividends he should have earned if the same amount was used to purchase shares of stocks.
Marginal costs are additional costs that will be incurred as a result of a business decision. For example, a company decides to add new product lines in its existing business. The marginal cost that may be incurred are those that will be utilized in the purchase of additional machinery and equipment; salaries for additional personnel to be hired; ...
Opportunity cost, marginal cost and relevant costs are examined.