Question

As there is still uncertainty about employees returning to work post COVID, the capital may need to be moved from its current interest bearing account elsewhere. Explain the opportunity cost associated with leaving the money in a bank account as opposed to other investment options that may mitigate the opportunity cost.

Answer 1

Introduction:-

The Covid 19 Pandemic has resulted in a lot of people losing out on their jobs as the total demand for goods and services remains low in the country. As a result of the same people do not come outside their houses to either do a job or to consume goods and services for themselves. This has resulted in a situation wherein most business owners are making significant losses.

The interest rates of banks in this situation have been reduced to all time low, primarily because the idea behind reduction is to increase expenditure and investment. As interest rates are lowered down, it becomes easier to take loans, while depositing the same in banks, leads to lesser interest generation as a revenue source. This is the main theme of this case study, and has been explained in detail in the next section.

It is important to note, that the core reason as to why people would want to remove their capital from its current interest giving account is that the rate of interest over the last 3 quarters has been reduced to a point, that it is extremely low. This is done so as to increase investment in a country.

Meaning of Opportunity Cost:-

Each resource which we are given as a producer, be it land, labor, capital etc. are all limited in number and size and have alternative uses. Opportunity cost is a concept which tells us that there is a price involved when we choose to put these resources into a specific area. This cost is that of the "next best alternative option" for which the resource could have been used.

For example, when we put our land towards setting up a factory, the same piece of land could have been used for other industries such as farming, agriculture etc. which may have also given similar or even greater profits. This difference in profit margins when we put our asset to use is known as opportunity cost of the asset.

Opportunity Cost of Leaving our Money in the Banks:-

When we decide in favor of leaving our money within the bank, we need to realize that this same source could have been used for other purposes. In the Covid situation, as described above, across most countries interest rates have fallen to the lowest levels.

At the same time, numerous industries such as pharmaceutical, foods and packed goods etc. are all in higher demand in which this very money can be deposited and this will help in increasing the returns for a business owner and therefore help in mitigating his opportunity cost loss which would be incurred if the money is kept in banks.

Thus, the opportunity cost of keeping your money in the bank is the alternative sectors in which we may invest this money and earn revenue from the same. This will help in reducing the same as we would then earn higher revenue than we would if the money was kept in the bank and low interest was earned on the same.

Conclusion:-

We can conclude by saying that the opportunity cost is the cost which we incur when we choose an alternative over another.

In this case, when we keep our money in the banks, we would earn a significantly lesser amount of money than we could if we chose to invest the money into various sectors such as pharmaceutical industry, consumer goods, food etc. all of which are doing good in most countries and earn higher revenue from the same instead of keeping the same with banks which would have given us much lesser interest rates respectively,

Please feel free to ask your doubts in the comments section if any.