Marginal Opportunity Cost: Definition, Formula And Calculations

Marginal Opportunity Cost
Marginal Opportunity Cost

Marginal opportunity cost is the change in the value of an opportunity caused by choosing one alternative over another.

In other words, it’s the next best alternative for when you choose an option that isn’t your first choice. Calculating marginal opportunity cost can be complicated, but don’t worry we’ve got you covered.

Use our step-by-step guide to find out how to calculate marginal opportunity cost in no time.

What Is Marginal Opportunity Cost?

In economic terms, marginal opportunity cost is the cost of foregone alternatives when making a decision. In other words, it’s what you give up when you choose one option over another.

For example, let’s say that I’m looking at two jobs. One pays $10 per hour while the other pays $12 per hour. The marginal opportunity cost of taking the higher paying job would be $2 per hour ($10 – $12).

To calculate this number, we divide the difference in pay by hours worked: $2/hour = $2/hr x 4 hrs. So for every four hours I work, I’d make an extra $8 by choosing the higher paying job.

 If preference is to maximize income without regard to total time spent working, then the best choice would be to take the more lucrative option regardless of how many hours it takes me to get there.

However, a goal was to minimize time spent working (and maximize leisure), then it might do better with the lower-paying position even though it pays less per hour.

ALSO CHECK: Constant Opportunity Cost: Why Does It Occur?

Example Of Marginal Opportunity Cost

The best way to understand this concept is by way of an example. Imagine you have a bakery and you’re trying to decide whether to make cupcakes or muffins.

The ingredients for each are similar, so the marginal opportunity cost of making one more cupcake is the same as the marginal opportunity cost of making one more muffin.

In other words, it’s the opportunity cost of using your resources (time, money, etc.) to produce one more unit of a good or service.

Marginal opportunity cost can be calculated in two ways. The first is comparing total revenue gained from producing one more unit with total variable costs; the second method calculates incremental revenue gained from producing one more unit minus incremental variable costs.

ALSO CHECK: Increasing Opportunity Cost: What Is The Law Of Increasing Opportunity Cost?

Increasing Marginal Opportunity Cost

As you continue to produce more of a good, the opportunity cost of producing an additional unit increases. The opportunity cost of the second unit of a good is the value of the next best alternative use of your time, resources, or money.

The marginal opportunity cost can be calculated by dividing the change in total opportunity cost by the change in quantity produced

 For example, if production of a product causes the total opportunity cost to increase from $400,000 to $430,000 and 10 units are produced; then the marginal opportunity cost for that tenth unit would be $40 per unit.

 The law of diminishing returns states that when one input (e.g., labor) is increased while all others remain constant, there will eventually come a point where adding more input becomes less productive than before. That point is called the maximum point of return on investment (MRROI).

ALSO CHECK: SWITCHING COSTS: Definition, Examples, Strategies

Marginal Opportunity Cost Formula

The marginal opportunity cost of production (MOCC) is the value of the next best alternative use of an input. In other words, it’s what you give up in order to produce something.

The MOCC formula is: MOCC = Marginal Revenue Product – Marginal Physical Product. To calculate the MOCC, you need to know the marginal revenue product (MRP) and marginal physical product (MPP).

The MRP is the additional revenue generated from the sale of one more unit of a good or service. MPP is the additional cost associated with producing one more unit of a good or service.

The MRP equals how much money each item sells for minus how much it costs to make that item. The MPP equals how much money each item costs minus how much money each item sells for.

One way to think about this is that if a company produces ten units and each unit sells for $100, then the MRP will be $1000.

 But if they only sold five units at $100 apiece, then their MRP would be only $500. Similarly, if they made fifteen units but only sold five at $100 apiece, then their MPP would be negative ($200), since they lost more than they gained by making those extra ten items.

ALSO CHECK: COST BENEFIT PRINCIPLE: Definition, Examples & How It Works

Opportunity Cost Vs Marginal Opportunity Cost

Most people are familiar with the concept of opportunity cost. Opportunity cost is defined as the value of the best alternative foregone.

In other words, it’s what you give up when you make a decision. For example, if you decide to go to college, you may have to forgo working and earning an income during that time.

 The opportunity cost of going to college would be the income you could have earned if you had worked instead. There are two types of opportunity costs

  1. Total Opportunity Cost: Your total opportunity cost includes both the marginal and total opportunities lost.
  2. Marginal Opportunity Cost while your marginal opportunity cost only considers how much your next-best choice was worth.

 If you’re faced with deciding between accepting a job offer or staying in school for one more year, your total opportunity cost would be the salary from the job offer plus all benefits minus what you would earn in one more year at school.

If this number exceeds the salary offered by the job, then you should take it. However, if taking another year at school will increase your lifetime earnings enough to exceed the salary offered by the job, then it’s better to stay in school. 

Your marginal opportunity cost of staying in school is simply the difference between what you’ll get from the job offer and what you’d get from taking another year at school.

Remember, there’s no way to calculate exactly how long it will take until one option becomes more valuable than the other.

ALSO CHECK: DIFFERENTIAL COST ANALYSIS: Examples & Application to Businesses

What Does Increasing Marginal Opportunity Cost?

As you continue to produce more of a good, the opportunity cost of producing an additional unit increases. The marginal opportunity cost is the opportunity cost associated with producing one more unit of a good.

 To calculate the marginal opportunity cost, you need to divide the change in total opportunity cost by the change in quantity produced. In order to understand how this calculation works, let’s consider two examples:

1) Suppose that you are running a factory that produces cars. The opportunity cost of producing each car is $10,000 per car.

If the factory can produce up to 100 cars each day (with an average production time of 8 hours), then it would take 8 hours*100 cars=800 hours=40 days worth of work to complete 100 cars.

So, the opportunity cost for making one more car is $10,000/car * 100 cars = $1 million.

2) A small business owner has hired four people to paint her house. Each person costs her $20 per hour ($80 per day).

If she hires all four people for eight hours at a time on three consecutive days, then the marginal opportunity cost for hiring one person for eight hours on the third day is $20/hour * 4 hours =$80.

Conclusion

The marginal opportunity cost is the cost of the next best alternative that you give up when you make a decision. In other words, it’s what you forego or lose out on when you choose one option over another.

The most popular formula for calculating the opportunity cost is given by C + P*x where C stands for cost and P stands for price

When calculating the MOC, you will have to find your current price (P) which is also called the prevailing market price. Then, multiply this number by your quantity (x). Finally, add any additional costs (C) incurred as a result of this purchase to get your total MOC.

For example, if you buy an apple at $2 and spend $5 on gas while driving there, then your total MOC would be $7 ($2+$5).

Similarly, if you buy some milk at 50 cents per gallon but only have 10 gallons left in your tank before running out of gas before home; then the opportunity cost of buying milk would be 30 cents per gallon.

Marginal Opportunity Cost FAQs

How Does Marginal Opportunity Cost Work?

The best way to understand marginal opportunity cost is by way of an example. Imagine you have a bakery and you’re trying to decide whether to make cupcakes or muffins.

The ingredients for each are similar, so the marginal opportunity cost of making one more cupcake is the same as the marginal opportunity cost of making one more muffin.

Where Does Marginal Opportunity Cost Apply?

The concept of MOC can be used to determine if a business should outsource certain tasks. Perhaps your retail store has become so busy you need to add extra employees, but that’s going to take some time.

Your MOC will tell you if it’s worth hiring more staff now or waiting until business slows down again.

How Is Opportunity Costs Calculated?

The opportunity cost of a good or activity is what you must give up in order to get it. In other words, it’s the next best alternative you give up when you make a decision.

 For example, if you are considering quitting your job for another one that pays twice as much but only has half the vacation time, then your current job represents your opportunity cost. You’ll have to decide which opportunity costs are worth more to you.

References

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