Opportunity Cost - Critique of a Concept

Abstract

When economists seek explanations for what creates value, they come across two problems: how to define value creation and how to measure it. A measure designated economic value added (EVA) has been gaining prominence in the last two decades. This measure is purportedly a more appropriate measurement of value creation by an economic entity. This measure has become widely known for asserting that all accounting measures suffer from a serious problem. They do not take the cost of equity capital into consideration. This concept has another dimension for its correct identification: it involves risk, as equity capital is more risky than third party capital and this characteristic should be taken into consideration. Furthermore, it proposes a definition for the cost of equity capital: this would be an opportunity cost. This article criticizes the concept of opportunity cost as relevant variable to measure the creation of value in a firm. Utilizing an example idealized by the classical economists, we show that the creation of value occurs in the process of production and the subtraction of a subjective amount (opportunity cost) cannot deny the existence of the creation of value.