Opportunity Costs: A Tool to Make Better Business Decisions

• In Event: Innovative and Emerging Issues 2

Abstract

Opportunity cost is a component of the collective concept of economic cost, which generally equals the difference between the costs of the desired and of the next best alternative. Economic costs are collectively composed of total costs (fixed costs plus variable costs as they appear in cost accounting), average costs (average fixed costs plus average variable costs), marginal costs, transaction costs, sunk costs and accounting costs besides opportunity costs. Businesses often make erroneous decisions because they ignore the costs necessary to apply the opportunity cost model. We propose models for calculating opportunity cost, including sunk costs, which the management accounting literature normally considers as irrelevant for decision-making purposes; discuss some strengths and weaknesses of these models; and relate opportunity costs to transfer pricing.

Authors

• Alan Reinstein, Wayne State University

• Mohamed Bayou, University of Michigan–Dearborn

• Gerald Lander, University of South Florida-St. Petersburg