Scale of Preference and Opportunity Cost

Scale of Preference:

You may have probably made a scale of preference in one way or another.

Scale of Preference is often considered to be brought about by the insatiability of human wants and limitation of cash at hand.

Note: By insatiability, we mean that human wants can never be satisfied; and just like Oliver Twist, we keep asking for more.

Please read on Values here.

Take for instance, when you take a young girl (of about 10 years old) to the supermarket; the girl will likely request for so many beautiful things from that supermarket. This is entirely normal for her to do but the question is: what if you don't have enough money to buy them?

You can read on the Disadvantages of Money here.

A scale of preference can be defined as the list of a person's needs or wants written in an order of importance.

From the above question, you can quickly map out a scale of preference and buy her what you think is important or best for her. You can probably explain your actions to her later and hopefully she will understand and appreciate you for it.

Please read on Demand and Law of Demand here.

Consider the table below:

The above table shows us what a scale of preference would look like.

You will observe that the person puts his most important needs or wants at the top of the list. Further down the list are his less important needs.

• A phone will be considered to be the most important; and it costs 50,000. He buys the phone.
• A console game according to this person is next in importance; and it costs 120,000. He buys the console game.

Another question worth asking is:

• What happens to his other needs?

This is where the term "Opportinity Cost" comes in.

Opportunity cost is value of the best alternative that a person could have achieved or bought but did not achieve it after the best choice had been achieved.

Please read on the Concept and Types of Cost here.

Now, you can guess that the Laptop, Ipad, Smart Watch and Ipod will all be classified under the opportunity cost. This is because the individual could not buy them after he bought his best choices.

Note: Laptop, Ipad, Smart Watch and Ipod refers to opportunity cost in the above instance.

Opportunity cost may be put into 2. These are:

• Explicit Opportunity Cost
• Implicit Opportunity Cost

Please read on Business and Characteristics of Business here.

Explicit Opportunity Cost

Opportunity cost is considered to be explicit when a person's financial resources is used for business. (The resources used for business will always be in the form of cash). Consider the instance below:

• Let's assume you have 2 million Naira, and decided to buy 2 cars. After the purchase of both cars, you gave out both to be managed by Mr. Tony and Mr. Bony; and they deliver you some money weekly from the car.

We can conclude that your explicit opportunity cost is the money (2 million Naira) spent on both cars; and that's because the cars were used as factors of production.

Please read more on production here.

Note: In the above instance, if you had not utilized your 2 million Naira in the way of explicit opportunity cost, then you may as well have donated it to a motherless baby home; but doing this nullifies it as an explicit opportunity cost. (That is, the 2 million naira no longer becomes an explicit opportunity cost).

Explicit opportunity cost involve the outflow of cash or other resources of yours to be used as factors of production.

Note: Explicit Opportunity Cost is sometimes referred to as out of pocket costs. and it may be recorded in the accounts book.

Please read on Journals here.

Other examples of explicit opportunity cost are money spent on wages, salaries and raw materials.

Implicit Opportunity Cost

Opportunity cost is considered to be implicit when there isn't any outflow of cash. Think of it this way:

Let's assume you own 2 cars and you directly use it yourself for your comfort and pleasure.

The truth is; you may have invested on both cars but you chose not to; and that's your implicit opportunity cost.

Please read on how to start a Home Based Fish Farming here.

We can thus say that an implicit opportunity cost does not require an outflow of cash and there isn't any returns of profit. It's what you already own and is being used by you.

An implicit opportunity cost is one where there isn't any form of cash outlay.

Implicit opportunity cost are not recognized by the accounting system since they belong to the owner.

Please read on the Differences between Bookkeeping and Accounting here.

Note: Implicit opportunity cost are sometimes referred to as imputed costs.

With regards to business, the implicit opportunity cost is the cost of the capital which the entrepreneur may have earned if he had invested somewhere else. The point is:

The entrepreneur did not invest somewhere else and that make's it an implicit opportunity cost.