Any business tries to use its resources efficiently. No one has unlimited resources, so it’s imperative that you use what you do have wisely. Those decisions are influenced by what economists call opportunity cost. Additionally, you’ll run into the law of rising opportunity costs in your small business as you devote more resources to a particular task.
When people discuss “cost,” they frequently refer to accounting cost, or the money spent on something. For instance, if your company decides to spend $1,000 on a computer, the accounting cost is also $1,000. But your purchase also comes with opportunity cost. You forfeit the opportunity to spend that $1,000 on something else by purchasing the computer. That “something else,” whatever it is, is the opportunity cost. According to The Library of Economics and Liberty, the total cost of using something is the highest cost of the best alternative use. Finding the use that has the lowest opportunity cost is frequently a task in determining the best use for money.
Opportunity cost exists even when youre not spending money. Say you own a store. You may lose a few sales if an employee is given the task of organizing the stockroom rather than serving customers because some of them may not receive assistance and leave empty-handed. However, if you place her on the sales floor while the stockroom is still disorganized, you risk losing additional sales as a result of your staff’s inability to find the items that customers want to purchase. Either option has an opportunity cost.
Increasing opportunity cost | Microeconomics | Khan Academy
Who uses the law of increasing cost?
Economists, financial analysts, accountants, and other economic professionals frequently employ the law of increasing cost in their work. Understanding the law of increasing costs can be useful for business owners as it frequently enables them to run their enterprises as effectively and efficiently as possible. This can assist business owners in maximizing their earnings, which can greatly aid in a company’s success. In order to maintain the financial stability of their business, business owners can find it very helpful to understand the law of increasing costs.
What is the law of increasing cost?
According to the economic principle known as the law of increasing cost, whenever a supplier increases the production of a good, the opportunity cost of producing additional goods also rises. When suppliers select one option over another and devote their resources to that option, they are said to be losing opportunities and benefits. In other words, opportunity cost is the difference between the price of the outcome that was chosen and the price of the alternative that a company could have chosen. The process of producing goods becomes less effective as the opportunity cost of doing so rises.
The law of increasing cost, which essentially states that when production factors are maximized, costs also increase, prevents suppliers from increasing the production of a good in an effort to increase their profits. The main factors of production include land, labor and capital. By altering certain aspects of their production processes, suppliers can occasionally avoid the effects of the law of increasing costs.
On a production possibility frontier (PPF) economic model, the law of increasing costs can be seen. A PPF is a graph that can show a company the various output configurations it can use to produce two goods using the same set of resources. A PPF is helpful because it enables you to analyze the graph’s curve, find the point with the highest production efficiency, and, as a result, make decisions that will benefit your business to the fullest extent possible.
Law of increasing cost example
Your small business’s increased production of laptop cases is an illustration of the law of rising costs. Typically, your company sells phone cases for $40 and laptop cases for $50. You make the decision to transfer some employees from your company’s phone case department to the laptop case department in order to help produce more laptop cases.
However, because they have more experience making phone cases than laptop cases, the staff in the phone case department ends up taking twice as long to produce a laptop case as the staff in the laptop case department. Therefore, you lose $80, the amount you would make from selling two phone cases, to make $50 from selling one laptop case when one of the people who makes phone cases makes one.
Law of increasing cost FAQ
The following are some typical queries about the law of increasing cost:
Why is the law of increasing cost important?
It’s crucial to comprehend the law of increasing costs because it can help you manage your company effectively and generate the highest profit. Additionally, being aware of the law of increasing costs can assist you in avoiding opportunity costs when producing goods and in making wise production decisions for your entire business. The law of increasing opportunity cost is also useful knowledge for those who work in resource management because it can help you decide how to allocate your production resources.
When should you use the law of increasing cost?
Before your company increases the production of a particular product, it is helpful to take into account the law of increasing cost. It can be useful to view your situation from the perspective of a production possibility frontier in order to comprehend the law of increasing cost as it applies to your company. You can visualize the potential output combinations if your company tries to produce two products using the same set of resources by using a production possibility frontier. This can assist you in making production decisions that will benefit your company the most.
Does the law of increasing cost cause profits to decrease?
Because of higher production costs, the law of increasing costs can occasionally lead to lower profit margins. However, opportunity costs can also include time, labor, and other elements in addition to profit. As a result, the law of increasing costs predicts that profit margins will typically decline as production rises, but other opportunity costs may also do so.
Does the law of increasing cost apply to every situation?
Production circumstances are not always subject to the law of increasing cost. In some circumstances, suppliers can alter their production processes to avoid or postpone the effects of the law of increasing costs. For instance, a supplier might decide to use a different, less expensive material for a product to make up for the higher production costs.
What is meant by law of increasing cost?
An economic principle known as the law of increasing opportunity cost explains how opportunity costs rise as resources are used. (In other words, there is a cost associated with using resources for one purpose over another each time they are allocated.) ).
What is an example of the law of increasing opportunity costs?
For instance, if your company decides to spend $1,000 on a computer, the accounting cost is also $1,000. But your purchase also comes with opportunity cost. You forfeit the opportunity to spend that $1,000 on something else by purchasing the computer. That “something else,” whatever it is, is the opportunity cost.
What is the law of increasing marginal cost?
According to the law of increasing marginal costs, marginal costs rise in the short term as more and more of something is consumed. The law of increasing marginal costs examines this idea through the lens of marginal costs, whereas the law of diminishing marginal returns examines it through the lens of marginal benefits.