What is Opportunity Cost?

What Is Opportunity Cost?

The basic economic problem is the issue of scarcity. Because resources are scarce but wants are unlimited, people must make choices. This lesson showcases the most important concept in macroeconomics, which is the concept of opportunity cost. Very simply, everyone has the same amount of hours in a day, but we all make different decisions about what we do, what we choose to buy, and how we spend our time. What determines these choices? Opportunity cost does.

Every time you make a choice, there is a certain value you place on that choice. You might not know it or think about it, but every choice has a value to you. When you choose one thing over another, you're saying to yourself, I value this more than another choice I had.

The opportunity cost of a choice is what you gave up to get it. If you have two choices - either an apple or an orange - and you choose the apple, then your opportunity cost is the orange you could have chosen but didn't. You gave up the opportunity to take the orange in order to choose the apple. In this way, opportunity cost is the value of the opportunity lost.

Value: Benefits And Cost

Value has two parts to it. It has benefits as well as costs. If you choose an apple over an orange, maybe the apple costs less, but maybe you enjoy it more. So, looking at choice in terms of benefits and costs helps you make better economic decisions. To make a good economic decision, we want to choose the option with the greatest benefit to us but the lowest cost.

Monetary Value

For example, if we graduate from college and suddenly find ourselves in the job market, there are choices to be made. Let's say that two jobs become available to us. We can either work for Company A or Company B. The job with Company A promises to pay us $20 an hour, while Company B offers to pay us only $10. Based on this information alone, of course most people would choose Company A.

Why? Because Company A is paying a higher salary. But when you look at this kind of a choice in only dollar terms, you're only seeing it from the perspective of the benefits. Let's take that same example, but now we discover that the job for Company A requires a fancy dress suit that will cost you $1,500. You realize that the job with the higher salary may not be worth it to you. Now you're starting to think economically. You're thinking economically when you look at the value of a choice through the eyes of its benefits and costs.

Whatever we choose, the opportunity cost is the value of the choice we could have had. The opportunity cost of working for Company A is the value of what we gave up to take the job. We gave up the value of working for Company B, so that is the opportunity cost of choosing to work for Company A. In this example, we focused more on the monetary costs. The challenge is, most people get stuck evaluating choices only in monetary terms, but there's more to the story.

Value Of Time

The value of a choice to you might be in terms of time or in terms of the enjoyment you could have experienced. When Benjamin Franklin originally explained this concept in his book, titled Advice to a Young Tradesman, he said that 'time is money.' He was trying to communicate the concept of opportunity cost by saying that what you do with your time, whether or not you are productive, can be just as important as any decision you make with money.

choices and opportunity cost

People's choices about what goods and services to buy and consume determine how resources will be used. The choices people make have both present and future consequences - consider for example the decision of students to stay on in full-time education after GCSE exams and A-Levels. You are forsaking some lost earnings in the short run (rarely can students study and hold down a full-time job!) but have the prospect of increased earnings potential in the future if you succeed on your course and achieve good grades.

There is a famous saying in economics that "there is no such thing as a free lunch". Even if we are not asked to pay for consuming a good or a service, scarce resources are used up in the production of it and there must be some opportunity cost involved - the next best alternative that might have been produced using those resources.

Opportunity cost measures the cost of any economic choice in terms of the next best alternative foregone

Many examples of opportunity cost exist at the level of the individual, the household, the firm, the government and the economy:

• The opportunity cost of deciding not to work is the lost wages foregone 
• The opportunity cost of spending money on a foreign holiday is the lost opportunity to buy a new dishwasher or the chance to enjoy two short breaks inside the United Kingdom
• The opportunity cost of the government spending £20 billion on interest payments on the national debt is the extra money it might have allocated to the National Health Service
• The opportunity cost of an economy investing its resources in new capital goods is the current production of consumer goods that is given up 
• The opportunity cost of using arable farm land to produce wheat is that the land cannot be used in that production period to harvest potatoes