Definition of opportunity cost

Resources | Subject Notes | Economics

The Basic Economic Problem - Opportunity Cost

The fundamental economic problem is that human wants are unlimited, but resources are scarce. This means we cannot satisfy everyone's desires. As a result, choices must be made. Every choice involves a trade-off. The concept of opportunity cost is central to understanding these trade-offs.

Definition of Opportunity Cost

Opportunity cost is the value of the next best alternative forgone when a choice is made. It represents what you give up to get something else. It's not just about the monetary cost, but also includes the value of the best alternative use of the resources.

Understanding Opportunity Cost

Consider a simple example: Suppose you have a free evening. You can either study for an exam or go to a concert. If you choose to go to the concert, the opportunity cost is the potential improvement in your exam grade you would have gained by studying. The opportunity cost is the value of the best alternative you didn't choose.

Why is Opportunity Cost Important?

Understanding opportunity cost is crucial for rational decision-making. It helps individuals, businesses, and governments make informed choices by considering the full cost of their actions, not just the explicit monetary cost.

Examples of Opportunity Cost

Here are some examples illustrating opportunity cost:

  • Studying vs. Working: The opportunity cost of studying is the wages you could have earned by working.
  • Investing in a Business vs. a Bond: The opportunity cost of investing in a business is the return you could have earned by investing in a bond.
  • Government Spending: The opportunity cost of a government spending money on healthcare is the other goods and services that could have been provided with that money (e.g., education, infrastructure).

Table Summarizing Opportunity Cost

Scenario Choice Made Next Best Alternative Forgone Opportunity Cost
Student Attending University Working Full-Time Potential wages and work experience
Business Investing in New Equipment Investing in Marketing Potential increase in sales from marketing
Government Building a New Hospital Investing in Education Potential improvements in educational outcomes

In essence, opportunity cost forces us to think about the true cost of our decisions – what we are sacrificing to obtain something else. It's a fundamental concept in economics that helps us understand scarcity and the need for choices.

Suggested diagram: A simple illustration showing a person choosing between two options (e.g., studying and working). The opportunity cost is represented by the unchosen option.