The Mother of All Costs: Opportunity Costs

In a world of infinite wants and scarce resources, even though we talk about fixed and variable costs, there is only one cost that businesses ever incur. You guessed it: opportunity cost. Let's see why.

Remember our friend Farmer Jones? When he decided to produce corn on his land, he couldn't produce potatoes. His opportunity cost was the forgone potatoes.

What happens if Farmer Jones buys a new tractor? A tractor is one of those fixed costs about which we spoke earlier. Once Farmer Jones uses his money to buy a tractor, he cannot use this same money to buy a combine. Farmer Jones has just incurred an opportunity cost, the forgone combine.

Suppose Farmer Jones spends his fertilizer. Fertilizer is a variable cost. Once Farmer Jones spends his money on fertilizer, he cannot spend this same money on insecticides. Farmer Jones has just incurred an opportunity cost, the forgone insecticides.

The bottom line of this discussion is that every time a business uses any resources, fixed or variable, it incurs opportunity costs.