Question

How does the opportunity cost enter into a make and buy decision? Explain and provide an example.

Answer 1

Opportunity cost is the cost of forgoing an alternative in favour of another alternative. Opportunity costs are relevant cost in evaluation of make vs. buy decision. Hence they should be considered in evaluation of make vs. buy decision making. Opportunity cost favours the external purchase since it will reduce the external purchase cost.

Examples:

· The cost of existing production facilities that can be rented out is opportunity cost. It will increase the existing cost of making the product or reduce the cost of buying from suppliers

· The contribution from new product which can be earned by firm because of purchase from external source is opportunity cost. It will increase cost of making the product that can be purchased outside or reduce the cost of buying from suppliers.