Consider two next-door neighbors, Sarah and John, living in identical apartments
ID: 1217972 • Letter: C
Question
Consider two next-door neighbors, Sarah and John, living in identical apartments in a condominium complex. John rents his unit for $2000/month. Sarah purchased her apartment (with cash) in a previous year for $200,000. Make the argument that the opportunity cost of both John and Sarah’s decision to reside in their apartment is $2000. Which opportunity costs is considered explicit? implicit? Should both John and Sarah consider their opportunity cost in making the decision to occupy their condominium unit?
Explanation / Answer
Opportunity cost is consists of implicit cost and explicit cost. Explicit cost is the cost which is clearly identified and reported while implicit cost is the oppportunity cost which has been foregone.
In the above example, 2000 $ is the cost to reside in the apartment.
Now John rents the apartment so he has 2000$ as the explicit cost while he does not have any implicit cost.
On the other hand, Sarah has bought the apartment for 200,000 $ so it is her ecplicit cost. However, if she decides to reside in that aprtment then foregone rent of 2000$ is her implicit cost.
In the decision making, oppportunity cost should be considered as it gives investor a chance to gain better returns while comparing different options.