Opportunity Cost Explained
OPPORTUNITY COST is what a person sacrifices when they choose one option over another.
Rajni is a “Sous- Chef” (second in command and direct under the Executive Chef ) at one of the best restaurants in the city. He earns a respectable salary of Rs. 200,000/YR. It’s a good job but he thinks he can do better, so he decides to start his own restaurant called “Rajni’s Restaurant”. In the first year he earns only 25% of what he made as a Sous-Chef or Rs. 50,000. The opportunity cost of starting his own business is the other 75% of the income that he would have made if he stayed at his old job or Rs. 150,000. Rajni doesn’t make too much for the first 4 years his restaurant is open and his opportunity costs are high. He earns only Rs. 200,000 instead of the Rs. 800,000 he would have earned if he were at his old job. So his opportunity cost is Rs. 600,000 (Rs. 800,000-Rs. 200,000).
Suddenly in year 5 Rajni’s Restaurant started receiving great reviews from food credits and earning top rankings (4.5 – Food; 4.5 – Décor; 4.5 – Service). His business is booming and he is making 5 times as much as he made at his old job (i.e. 5 *Rs. 200,000) or Rs. 1,000,000/Yr. He realizes that if he was still working as Sous-Chef his opportunity cost would now be Rs. 800,000/YR (Rs. 1,000,000/YR – Rs. 200,000/YR).
Although Rajni sacrificed income and his opportunity cost was high in the short term; in the long run his opportunity cost would have been higher if he had not opened his own restaurant!