What is Opportunity Cost?
Updated 7/5/2018 Jacob Reed
The study of economics focuses on the problem of scarcity; that resources are limited and insufficient to fulfill human wants. That scarcity forces us to make choices and those choices have costs. This review page covers this basic economic concept of opportunity cost. After you finish reviewing these concepts, test your knowledge with a 20 question review game on calculating opportunity cost, profit, revenue, and firm costs. The first 5 of those questions are specifically about opportunity cost.
Economists like to say every choice has a cost. That cost is called an opportunity cost. In economics, cost isn’t just about money; it is about lost opportunities. For example, if you chose to go to soccer practice, you lose the opportunity to hang out with your friends. Hanging out with your friends is your opportunity cost. Opportunity cost is the value of the best alternative not chosen.
Here is another example, let’s say your friend offers to buy you lunch. You could eat a hamburger, salad, sandwich, or burrito (these are all of your alternatives). You decide to get the burrito. The burrito is your choice (the best alternative). Your opportunity cost is the second best choice available or what you would have gotten if the burrito wasn’t available? If that was the hamburger, then the hamburger is your opportunity cost for choosing the burrito.
Calculating Opportunity Cost: Many times on an exam you will see questions that requires you to calculate opportunity cost. The key to answering these questions is to focus on the cost of the choice. If someone loses the opportunity to earn money, that is part of the opportunity cost. If someone chooses to spend money, that money could be used to purchase other goods and services so the spent money is part of the opportunity cost as well. Add the value of the next best alternatives (the opportunities that would have been chosen had the choice not been available) and you have the total opportunity cost. If you miss work to go to a concert, your opportunity cost is the money you would have earned if you went to work plus the cost of the concert ticket.
Opportunity cost on the Production Possibilities Curve: The production possibilities curve illustrates different combinations of two goods (or groups of goods) that can be produced with fixed resources. When answering questions about opportunity cost on a PPC graph, just look to the axes. Take a look at the PPC graph to the right. If this economy produces at point 2 instead of point 1, the opportunity cost of 6 additional units of consumer goods is 13 units of capital goods.