Introduction to Economics: The Concept of Opportunity Cost

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Opportunity cost is an interesting concept of economics because it doesn’t necessarily pertain to money; although it can certainly relate to money. One of the primary principles of opportunity cost is the concept of value.

Pretty much everyone experiences a level of opportunity cost on a daily basis in various aspects of their lives since there are many things in life that are considered valuable.

With opportunity cost, there is a strong correlation between worth and opportunity, and what it fundamentally comes down to is the fact everything has some sort of value. It could be monetary value, or there may be an emotional value attached. The level of this worth is what determines the amount of opportunity cost involved in any given situation.

Where’s the value?

The economic way of thinking explains wealth as whatever it is people deem valuable, it doesn’t necessarily have to be money. Tangible items, such as money, jewels, clothing, or water all can have worth and are considered material value. On the same token, items such as a serenity, happiness or even excitement are also valuable to some people and are an emotional kind of value. Much like beauty, what has worth to an individual is based on the eye of the beholder. Items may be very valuable to one person and considered worthless to another.

As an example, cold weather is frustrating to many people because they either don’t like cold hate the added expense of fuel. On the other hand, the person who runs the local fuel company greatly anticipates the colder season because it is more profitable for them. Cold weather is very valuable to the second person, whereas the first sees cold weather as worthless and costly.

Why is the concept of worth important when talking about opportunity cost?

The reason why having a solid grasp on worth is important when trying to understand opportunity cost is because when people make choices they most often have to forego another option in favor of selecting the one most appealing or the choice they want the most. Everyday individuals are faced with decisions to make, and at each crossroad of choice comes some sort of trade-off when the decision is made. What people trade-off and do not gain from their choice is the amount of opportunity cost. Basically, it comes down to missed opportunity.

Take this example:

You have the day off from work and you have different options of ways you could spend the day. You could go to the stores and hit some good sales for items you’ve wanted or needed to buy, or you could go to the beach and relax. If you choose the beach, your opportunity cost would be missing out on the sales and not get the items you want at a good price. In this case, there is a tangible value lost in that comes in the form of money.

On the other hand, if you choose the sales, your opportunity cost is missing out on what may be a rare chance to have a completely relaxed day at the beach. The loss of that precious relaxation time may be a true value for you and, thus if not chosen, is an opportunity cost.

Choices, choices, choices

In terms of business, opportunity costs come all the time. There are choices to make in terms of management, hiring, investing or marketing to name a few business processes. Those in charge of decision making have to weigh out all the opportunities to try to pick the route which best closely identifies with what they want more.

Say two applicants apply for a job. One applicant is more experienced, but the other has the better ability to be flexible with scheduling which the job requires. The hiring manager can go with experience, or go with the person who is guaranteed to show up for every shift. Regardless of which applicant is chosen, there is going to be an opportunity cost.

Essentially, opportunity cost is about sacrifice. Every day, either in personal life or business, people make sacrifices when choices are made. While both choices may be wanted, often this is not possible and one must be chosen. Ultimately, an individual has to choose the one they want more.

The one chosen is the net benefit, and the option not chosen is the cost of the benefit; this will illuminate the amount of opportunity cost.


Additional source: Investopedia – http://www.investopedia.com/terms/o/opportunitycost.asp