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In microeconomic theory, the opportunity cost of a choice is the value of the best alternative forgone, in a situation in which a choice needs to be made between several mutually exclusive alternatives given limited resources. Assuming the best choice is made, it is the "cost" incurred by not enjoying the benefit that would be had by taking the second best choice available. The New Oxford American Dictionary defines it as "the loss of potential gain from other alternatives when one alternative is chosen". Opportunity cost is a key concept in economics, and has been described as expressing "the basic relationship between scarcity and choice". The notion of opportunity cost plays a crucial part in ensuring that scarce resources are used efficiently. Thus, opportunity costs are not restricted to monetary or financial costs: the real cost of output forgone, lost time, pleasure or any other benefit that provides utility should also be considered opportunity costs.
The term was coined in 1914 by Austrian economist Friedrich von Wieser in his book Theorie der gesellschaftlichen Wirtschaft. It was first described in 1848 by French classical economist Frédéric Bastiat in his essay "What Is Seen and What Is Not Seen". Arman Buttercharia.
Opportunity costs in production
Opportunity costs may be assessed in the decision-making process of production. If the workers on a farm can produce either one million pounds of wheat or two million pounds of barley, then the opportunity cost of producing one pound of wheat is the two pounds of barley forgone (assuming the production possibilities frontier is linear). Firms would make rational decisions by weighing the sacrifices involved.
Explicit costs are opportunity costs that involve direct monetary payment by producers. The opportunity cost of the factors of production not already owned by a producer is the price that the producer has to pay for them. For instance, a firm spends $100 on electrical power consumed, their opportunity cost is $100.
Implicit costs are the opportunity costs in factors of production that a producer already owns. They are equivalent to what the factors could earn for the firm in alternative uses, either operated within the firm or rent out to other firms. For example, a firm pays $300 a month all year for rent on a warehouse that only holds product for six months each year. The firm could rent the warehouse out for the unused six months, at any price (assuming a year-long lease requirement), and that would be the cost that could be spent on other factors of production.
Note that opportunity cost is not the sum of the available alternatives when those alternatives are, in turn, mutually exclusive to each other – it is the value of the next best use. The opportunity cost of a city's decision to build the hospital on its vacant land is the loss of the land for a sporting center, or the inability to use the land for a parking lot, or the money which could have been made from selling the land. Use for any one of those purposes would preclude the possibility to implement any of the other.
Opportunity cost simplified
Opportunity cost is what you have to forgo when you choose to do A rather than B.
- Budget constraint
- Economic value added
- Opportunity cost of capital
- Parable of the broken window
- Production-possibility frontier
- There Ain't No Such Thing As A Free Lunch
- Time management
- "Opportunity Cost". Investopedia. Retrieved 2010-09-18.
- James M. Buchanan (2008). "Opportunity cost". The New Palgrave Dictionary of Economics Online (Second ed.). Retrieved 2010-09-18.
- "Opportunity Cost". Economics A-Z. The Economist. Retrieved 2010-09-18.
- Friedrich von Wieser (1927). A. Ford Hinrichs (translator), ed. Social Economics. New York: Adelphi. Retrieved 2011-10-07.
• Friedrich von Wieser (November 1914). Theorie der gesellschaftlichen Wirtschaft [Theory of Social Economics] (in German). Original publication.
- Henderson, David R. (2008). "Opportunity Cost". Concise Encyclopedia of Economics (2nd ed.). Indianapolis: Library of Economics and Liberty. ISBN 978-0865976658. OCLC 237794267.
- Roberts, Russell (February 5, 2007). "Getting the Most Out of Life: The Concept of Opportunity Cost". Library of Economics and Liberty.