Scale of Preference and Opportunity Cost

Scale of Preference:

You may have 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.

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

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?

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.

Consider the table below:

 Needs / Wants Cost (Naira) Phone 50,000 Console Game 120,000 Laptop 80,000 Ipad 100,000 Smart watch 85,000 Ipod 40,000

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. Now, let's imagine that this individual has 170,000 Naira to spend. According to the above scale of preference, the followings can be deduced;

• 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.

• 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.

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 two. These are:

• Explicit Cost
• Implicit Cost

Explicit Cost

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 respectively; and they deliver you some money weekly from the car.

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

In the above instance, if you had not utilized your 2 million Naira in the way of explicit cost, then you may as well have donated it to a motherless baby home; but doing this nullifies it as an explicit cost. However, if the donation to a motherless baby home becomes your next best alternative which you could not achieve (as a result of buying both cars), then such unachievable donation becomes your explicit opportunity cost since this is what you would have done if you hadn't bought both cars.

Explicit cost involve the outflow of cash or other resources of yours to be used as factors of production. However, always understand that the next best alternative which you could not achieve with the outflow of cash becomes your explicit opportunity cost.

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

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

Implicit Cost

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 both 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 cost.

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

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

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

Implicit cost are sometimes referred to as 'imputed costs'.

With regards to the above instance, the implicit opportunity cost will become the comfort and pleasure which the you may have enjoyed from something else aside both cars. For instance, you could have chose comfort in a private jet instead of both cars. The point is:

You did not buy the private jet and could not enjoy its comfort, hence making it your implicit opportunity cost.

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