Yip, David S.O
(1999)
A critical review of the opportunity cost concept.
PhD thesis, London School of Economics and Political Science.
Abstract
The opportunity cost concept has been advocated as the prime decision cost concept by economists and accountants, notably scholars of the London School since Nineteen Thirties. However, there are certain conditions as discussed by Edwards (1937) and Coase (1938) which have to be met before the opportunity cost concept can be functionally applied in the accounting context. Moreover, there are few research into the decision practices of accountants and business managers relating to the application of the opportunity cost concept in business decisions. Thus, it is uncertain if the concept is adopted in practices by managers and executives. The purposes of this paper are, therefore, to carry out a critical review of the opportunity cost concept, both in terms of its theoretical validity and its applicability to the business context, as well as to investigate whether the concept has actually been adopted in practice for business decisions. Based on the contents of the agency theory, behavioural decision theory (which includes the Resouceful, Evaluative, Maximising Model), expectancy theory, and the theory of choice, a model which is termed the Expectancy Decision Processing Model is proposed to explain the decision behaviour of business managers and how they would adopt or otherwise the opportunity cost concept, represented by the opportunity cost accounting model within the accounting context, in making decisions under different circumstances. Results of the analyses indicate that accountants and managers very often do not invoke the opportunity cost accounting model in making decision calculations. Managers will only invoke the opportunity cost accounting model in calculating the possible payoffs of different decision alternatives when two conditions are satisfied. The first condition is that they find no difficulty in making use of the opportunity cost accounting model; the second condition is that the opportunity cost accounting model will provide a priority ranking of the decision alternatives that is desired by the managers who are maximising their own decision benefits.
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