What Opportunity Cost Depends On

Opportunity cost depends on Scarcity of Resources, as the fundamental limitation on the availability of factors of production dictates the trade-offs that must be made between different alternatives.

Key Dependencies

• Scarcity of Resources — without this, opportunity cost would not exist, as there would be no need to make trade-offs between different alternatives. The Soviet Union's economy, which was characterized by a lack of scarcity due to centralized planning, ultimately failed to allocate resources efficiently, leading to widespread shortages and economic stagnation.
• Alternative Uses — opportunity cost requires that resources have alternative uses, so that choosing one option means forgoing another. The failure of the Concorde supersonic jet program, which was cancelled due to rising costs and lack of alternative uses for the technology, demonstrates the importance of considering alternative uses when evaluating opportunity cost.
• Trade-Offs — opportunity cost depends on the existence of trade-offs between different options, so that choosing one option means giving up another. The US auto industry's failure to adapt to changing consumer preferences, which led to a decline in market share, illustrates the importance of considering trade-offs when evaluating opportunity cost.
• Marginal Analysis — opportunity cost requires marginal analysis, which involves evaluating the additional benefits and costs of a particular option. The failure of the DeLorean Motor Company, which failed to conduct adequate marginal analysis and ultimately went bankrupt, demonstrates the importance of considering marginal benefits and costs when evaluating opportunity cost.
• Time Preference — opportunity cost depends on time preference, as the value of resources can change over time. The failure of the Soviet Union's five-year plans, which failed to account for changes in time preference and ultimately led to economic stagnation, illustrates the importance of considering time preference when evaluating opportunity cost.
• Risk and Uncertainty — opportunity cost depends on risk and uncertainty, as the value of resources can be affected by unforeseen events. The failure of the Long-Term Capital Management hedge fund, which failed to account for risk and uncertainty and ultimately went bankrupt, demonstrates the importance of considering risk and uncertainty when evaluating opportunity cost.

Priority Order

The dependencies can be ranked in order of priority as follows:

• Scarcity of Resources: this is the most critical dependency, as without scarcity, opportunity cost would not exist.
• Alternative Uses: this is the second most critical dependency, as alternative uses provide the basis for evaluating opportunity cost.
• Trade-Offs: this is the third most critical dependency, as trade-offs are necessary for evaluating opportunity cost.
• Marginal Analysis: this is the fourth most critical dependency, as marginal analysis is necessary for evaluating the additional benefits and costs of a particular option.
• Time Preference: this is the fifth most critical dependency, as time preference affects the value of resources over time.
• Risk and Uncertainty: this is the sixth most critical dependency, as risk and uncertainty affect the value of resources, but can be mitigated through diversification and hedging.

Common Gaps

People often overlook the importance of Scarcity of Resources and Alternative Uses when evaluating opportunity cost, assuming that resources are abundant and that there are no alternative uses. This can lead to a failure to consider the trade-offs involved in a particular decision, and ultimately to poor decision-making. For example, the failure of the US auto industry to adapt to changing consumer preferences was due in part to a failure to consider the alternative uses of resources, such as investing in more fuel-efficient vehicles.