Difference Between Opportunity Cost and Marginal Cost

Opportunity Cost vs Marginal Cost

The concepts of opportunity cost and marginal cost are important in the case of industries where goods are being produced. Though not directly linked to each other, they play an important role in deciding increase of production in the most profitable manner. This article will take a closer look at the two concepts and see if any differences exist between the two.

What is Opportunity Cost?

Opportunity cost refers to the sacrifice of the highest value of a product that a company has to make to produce another item. In other words, it refers to the benefit that one has to forego by taking an alternative action. In terms of investments, it is the difference in return between a chosen mode of investment and another that has been ignored or passed up. If you had an option of investing in a stock that yields 10% in a year but opted in another stock that yielded only 6%, your opportunity cost is said to be the difference which in this case is 4%.

In real life, we are often faced with several opportunities and choose one that we deem better for us. In doing so, we have to give up on other alternatives that sum up as opportunity cost. If an executive enrolls in an MBA program as he is not satisfied with the salary he is getting at present as he anticipates better salary after becoming MBA, he incurs an opportunity cost that is the sum of his salary in a year and the annual fee of the business school. However, in real life situations, it is not so simple and easy to calculate opportunity cost one incurs in choosing an alternative by giving up on another.

What is Marginal Cost?

Marginal cost is a concept that is applicable in production units and refers to change in total cost if an additional piece is produced in a cycle of operation. Thus it is represented as the cost required to produce an additional unit.

Suppose in a small factory, 100 pieces are being produced in a day and the owner decides to produce one more unit, then he not only requires additional raw material, he also requires to pay overtime to his skilled labor that will weigh on his mind before he decides to step up the production. In the case of a factory operating at its highest capacity, marginal cost may be high. However, in general, as one can purchase raw material in bulk getting them cheaper, producing more generally results in falling of marginal cost.

Marginal cost varies greatly from industry to industry and also from one product to another. Some economists prefer to call marginal cost as the opportunity cost associated with producing an extra unit. If profits are higher than the cost incurred on producing an extra unit, the owner may well indulge in producing this extra unit. If however, the opportunity cost is higher than profits that are eventually realized, the factory owner decides in favor of not going in for an additional unit.