A Transfer of Cost

Here is an example.

• The Activity: Suppose that Chip Merthington, a typical fun-loving Shady Valley teenager, is hired as a part-time employee at the CD Music Emporium in the Shady Valley Sprawling Hills Shopping Mall. Chip spends four hours each afternoon stocking CD's and assisting customers.


• The Opportunity Cost: The four hours Chip spends at the CD Music Emporium is time that cannot be spent pursuing other activities. Chip's best, most satisfying alternative, would be playing video games with his friends at Alicia Hyfield's house. The opportunity cost of working at CD Music Emporium is this foregone satisfaction.


• The Payment: Fortunately, Chip receives $5 for each hour of work at the CD Music Emporium. This payment compensates Chip for his foregone satisfaction. If not, then he would probably choose not to work. Chip then uses this compensation to purchase other consumer satisfying goods, such as evenings spent eating pizza and watching movies with Alicia Hyfield. Chip, at worst, breaks even.


• The Transfer: The opportunity cost of foregone satisfaction is effectively transferred to the CD Music Emporium through the monetary payment of Chip's wage. In particular, the owners of CD Music Emporium now have less money (profit) that can be used to purchase consumer satisfying goods. As such, the CD Music Emporium owners are now incurring the opportunity cost of foregone satisfaction resulting from Chip's employment.

Out-of-Pocket Payment

A word or two about accounting cost seems in order:

• First, not all accounting cost is opportunity cost. That is, in some cases an explicit payment is made by a firm but not in compensation of foregone satisfaction. It might be recorded by a firm as accounting cost, but it is actually economic profit. For example, CD Music Emporium also employs Randy Goodluck, who happens to be the nephew of the head of the company. Randy never shows up for work and does not actually do anything productive. Randy's $5 "wage" is recorded as an accounting cost, but it is really part of the company's profit, not compensation for opportunity cost.


• Second, accounting cost does not necessarily reflect all opportunity cost incurred by a business firm for production. The official, out-of-pocket, accounting cost might not fully compensate for the opportunity cost. For example, Suzanne Haberstone is also employed by CD Music Emporium making the same $5 hourly wage as Chip and Randy. Suzanne is a licensed massage therapist and charges $50 per hour for her services. Each hour spent working at CD Music Emporium means Suzanne is foregoing $50 of massage therapy. Her wage is also an accounting cost, but it does not fully reflect the opportunity cost she incurs.

An Implicit Alternative