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| Corporate Practice bd |
What is Sun cost VS Opportunity cost with Practical Examples
Sunk costs and opportunity costs are both important concepts in economics and decision-making, but they represent different aspects of cost analysis.
Sunk Costs:
Definition: Sunk costs are costs that have already been incurred and cannot be recovered. These costs are irrelevant to future decision-making because they are past expenditures that cannot be changed or recouped.
Characteristics:
They are historical costs that have already been spent. Sunk costs should not influence future decisions because they are not relevant to the decision at hand.
Example: Suppose a company has spent $100,000 on developing a new product, but after realizing it's not viable, they have to decide whether to continue investing in it. The $100,000 already spent is a sunk cost—it cannot be recovered regardless of whether they continue or abandon the project.
Opportunity Costs:
Definition: Opportunity costs represent the value of the next best alternative foregone when a decision is made. It reflects the benefits that could have been gained by choosing an alternative course of action.
Characteristics:
Opportunity costs are forward-looking and focus on the benefits foregone by choosing one option over another.
They are subjective and can vary depending on individual preferences and circumstances.
Example: If you have the option to either work overtime and earn $200 extra or spend time with your family, the opportunity cost of choosing to work overtime is the enjoyment and time spent with your family that you're missing out on.
Difference:
Temporal Aspect:
Sunk costs are historical and cannot be changed, while opportunity costs are forward-looking and involve potential future benefits.
Relevance to Decision-making:
Sunk costs should be ignored in decision-making because they are irrelevant to future choices, whereas opportunity costs are essential considerations in decision-making as they represent the benefits sacrificed by choosing one option over another.
Focus:
Sunk costs focus on past expenditures, while opportunity costs focus on potential future benefits.
In summary, while sunk costs represent past expenditures that should not influence future decisions, opportunity costs represent the benefits foregone by choosing one alternative over another and play a crucial role in decision-making.