Betty has a degree in fine arts, and makes a unique product decorative bottle-cap pins. She paints recycled bottle caps with attractive images, and attaches a pin so the bottle caps can be displayed on sweaters or jackets. She has asked you to compute the annual cost of her business. She uses machines and tools that have a current market value of $10,000. The annual cost of her raw materials (bottle caps, paint, pins) is $2,000. She could be earning $30,000 in another job.
We can use the principle of opportunity cost to compute Betty s costs. In addition to the $2,000 cost of raw materials, we must include two other sorts of costs:
Opportunity cost of funds invested. Betty could have invested the $10,000 in a bank account. If the interest rate on a bank account is 8 percent, the annual cost of her capital (machines and tools) is the $800 she could have earned in a bank account during the year.
Opportunity cost of her time. The opportunity cost of Betty s time is the $30,000 salary she sacrifices by being her own boss.
Adding the $800 cost of funds and the $30,000 cost of her time to the $2,000 materials cost, we find Betty s cost of doing business is $32,800 per year.