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September 19, 2018 

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HARROD-DOMAR MODEL: A model economic growth developed by R. F. Harrod and E. D. Domar that seeks to explain why an economy would not grow as fast has its potential growth rate. This model is based on the notion that actual income determines the amount saving, which is determines investment, which is what affects the rate of economic growth. If saving is not enough, the potential growth rate will not be achieved. The Harrod-Domar model, developed in the 1930s, has a strong Keynesian economic flavor, both indicating that the economy does not automatically achieve its potential.

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OPPORTUNITY COST:

The highest valued alternative foregone in the pursuit of an activity. Opportunity cost is a one of the most fundamental concepts used in the study of economics. An opportunity cost can be either explicit, usually involving a monetary payment, or implicit, which does not involve a transaction. Opportunity cost is also commonly termed economic cost.
The ultimate source of opportunity cost is the pervasive problem of scarcity (unlimited wants and needs, but limited resources). Opportunity cost is fundamental to the study of economics (and life) because scarcity is fundamental to the study of economics (and life). Whenever limited resources are used to satisfy one want or need, an unlimited number of other wants and needs remain unsatisfied. Hence pursuing one activity means alternatives are not pursued. Herein lies the essence of opportunity cost. Doing one thing prevents doing another.

The term economic cost is often used synonymously with opportunity cost. Replacing "opportunity" with "economic" serves to punctuate the central role opportunity cost plays in economics. It also distinguishes "cost" as used in economics, with "cost" as used in other disciplines, like accounting.

Because economists like to economize on effort, the succinct term cost is also frequently used in lieu of opportunity cost or economic cost. In fact, whenever the term cost is used in economics, absent of any modifiers, it generally means opportunity cost.

More Details on Cost

Three phrases in the definition of opportunity cost warrant further discussion--alternative foregone, highest valued, and pursuit of an activity.
  • Foregone Alternative: Opportunity cost is all about foregone alternatives, about not pursuing an activity. Reading this entry on opportunity cost means not reading a classic novel by F. Scott Fitzgerald (or more realistically not watching an episode of the television show, Brace Brickhead: Medical Detective). Scarce resources have alternative uses. Using resources to satisfy one want or need means they cannot be used to satisfy another. The opportunity cost of foregone alternatives is often illustrated using production possibilities analysis.

  • Highest Valued: Opportunity cost is not concerned with ALL possible alternatives, only the best alternative, the highest valued alternative that would have been pursued. Unlimited wants and needs means an unlimited number of alternatives exist for every activity undertaken. But opportunity cost is not about every possible alternative, only about the best alternative. The opportunity cost of reading this entry on opportunity cost would be the satisfaction that would have been obtained from Brace Brickhead: Medical Detective, if watching television is the highest valued alternative foregone.

  • Pursuit of an Activity: Economics is the study of doing things--surfing the web for economic concepts, watching television, eating hot fudge sundaes. More to the point, economics is the study of how scarce resources are used to address society's unlimited wants and needs. The phrase pursuit of an activity specifically means that society is using resources to produce goods that are consumed to satisfy wants and needs. The primary activities pursued in this context are usually production and consumption.

Explicit and Implicit

Opportunity cost is the value of the best foregone alternative. In some cases the opportunity cost also involves some sort of monetary transaction or compensation. In other cases there is no compensation, monetary or otherwise. This distinction gives rise to two types of opportunity cost--explicit and implicit.
  • Explicit Cost: This is an opportunity cost that involves a money payment and usually a market transaction. The money payment is generally made to compensate the person who has incurred the actual opportunity cost and foregoes the satisfaction. This payment, in effect, transfers the burden of the opportunity cost from the original person to the one making payment.

    Suppose, for example, that Chip Merthington takes a job working four hours each day at the CD Music Emporium in the Shady Valley Sprawling Hills Shopping Mall. While at work, Chip foregoes satisfaction from playing video games and hanging out with friends. He is the person directly incurring the opportunity cost from this job. However, because Chip is paid an hourly wage, this cost is transferred to the CD Music Emporium. The CD Music Emporium is thus incurring an explicit cost.


  • Implicit Cost: This is an opportunity cost that DOES NOT involve a money payment or market transaction. The person incurring the opportunity cost and foregone satisfaction is not compensated and the cost is not transferred to anyone else.

    Consider the situation facing Chip's friend Edgar Millbottom. Edgar also works four hours a day in the Shady Valley Sprawling Hills Shopping Mall. However, Edgar works at Waldo's TexMex Taco World, which happens to be owned by his father Waldo Millbottom. While at work, Edgar also foregoes satisfaction from playing video games and hanging out with friends. However, Edgar does not receive a money payment to compensate for his foregone alternatives. Edgar is thus incurring an implicit cost.


<= OPEN MARKET OPERATIONSOPPORTUNITY COST, PRODUCTION POSSIBILITIES =>


Recommended Citation:

OPPORTUNITY COST, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2018. [Accessed: September 19, 2018].


Check Out These Related Terms...

     | cost | economic cost | explicit cost | implicit cost | free good | free resource | accounting cost | normal profit |


Or For A Little Background...

     | scarcity | limited resources | unlimited wants and needs | satisfaction | value |


And For Further Study...

     | economics | dismal science | three questions of allocation | division of labor | economic good | first rule of scarcity | production possibilities | opportunity cost, production possibilities | market supply | production cost | total cost | marginal cost | average cost | long-run average cost | law of diminishing marginal returns |


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