Opportunity Cost

Definition

Opportunity cost is a fundamental concept in economics.
It is defined as the cost of forgoing the next best alternative when making a decision.
In other words, it’s what you ‘give up’ in order to do or have something else.
The idea of opportunity cost applies to both individual and societal decisions.

Every choice made involves an opportunity cost.
This is because resources such as time, money, and materials are limited and need to be allocated effectively.
Scarcity, the basic economic problem of having human wants that exceed available resources, necessitates the concept of opportunity cost.
Even free goods have opportunity costs if the resources used to produce them can be used to produce something else.
It’s important to remember that opportunity cost doesn’t refer to the sum of all possible alternatives, but rather the most desirable alternative among them.

If a government decides to spend more on defence, the opportunity cost might be less spending on healthcare or education. The higher defence spending may result in a safer country, but the quality of healthcare or education could suffer as a result.
If a person decides to spend an hour watching a film, their opportunity cost could be an hour they could have spent reading, earning money, or doing anything else that would’ve been the next best alternative.

To calculate the opportunity cost of a decision, subtract the value of the chosen option from the value of the next best alternative.
Specifically, opportunity cost = benefit of next best alternative not chosen - benefit of chosen option.

Understanding opportunity cost helps in making rational economic decisions and maximising utility.
It aids in evaluating the true cost of a good or service, an action, or a decision.
It’s used in comparative advantage theory to illustrate the potential gains from trading and specialisation.
It plays a vital role in ensuring efficient use of scarce resources.

It’s often difficult to accurately estimate the cost or benefit of an opportunity, especially when they are intangible or indirect.
Some critics argue that focusing on opportunity cost could promote a self-centered approach to decision making, as it doesn’t consider the overall societal impact.
It can be a simplification of complex choices as it doesn’t always account for multiple alternatives or the fact that some choices can lead to multiple outcomes.