Question

Explain the concept of opportunity cost and the Law of Diminishing Returns. How are they related? Why economists use the concept of opportunity cost when they want to determine cost rather than the traditional view of cost, i.e., cost out of pocket? Illustrate with an original and relevant example these concepts and how they are related.

Answer 1

Answer : Oppounity cost is the cost of next best alternative has been forgone. It means that everything that we have forgone has cost related to them. As it shows that next best alternative good that could be produced with same value of goods and services.

As opportunity cost means something has been given up when we make a choice or perfect decision. EXAMPLE : A student has $1000 than either he spends on higher education or on shopping. The student opportunity cost of education is shopping.

Law of diminishing returns means that adding more and more input or factors for the production of output resulted in a smaller increase in the output. After reaching optimal level of output which resulted in an increase in the production provided a increase in input does not result same level of increase in the output.

EXAMPLE : As firm should hired more and more labour which results in an increasing output but after certain level adding additional labour does not provide same level of increase in output.

Answer : Economist has been taken into account oppournity cost while taking decision in the firm and not taken out of pocket cost in the decision.As opportunity cost means cost of best alternative forgone where out of pocket cost expenses related to implementing particular decision. It means that wise decision should be taken in order to make best use of resource available. Proper decision and rules should be implemented if opportunity cost has been taken into an account and best decision should be taken. Example : Mr ram is graduate either run a business or doing a job. In the job he earns $50,000 in a year where as doing business earns revenue of $80,000 and expenses of $60,000 so he earn profit of$20,000.

Here , opportunity cost is $50,000 for doing a business and out of pocket cost is $60,000