What is Opportunity Cost?

Aug 09, 2017 06:36 pm

What is Opportunity Cost?

Opportunity Cost is the highest valued alternative foregone in the pursuit of an activity. Opportunity cost is a one of the most fundamental concepts used in the study of economics. An opportunity cost can be either explicit, usually involving a monetary payment, or implicit, which does not involve a transaction. Opportunity cost is also commonly termed economic cost.

The ultimate source of opportunity cost is the pervasive problem of scarcity (unlimited wants and needs, but limited resources). Opportunity cost is fundamental to the study of economics (and life) because scarcity is fundamental to the study of economics (and life). Whenever limited resources are used to satisfy one want or need, an unlimited number of other wants and needs remain unsatisfied. Hence pursuing one activity means alternatives are not pursued. Herein lies the essence of opportunity cost. Doing one thing prevents doing another. The term economic cost is often used synonymously with opportunity cost. Replacing "opportunity" with "economic" serves to punctuate the central role opportunity cost plays in economics. It also distinguishes "cost" as used in economics, with "cost" as used in other disciplines, like accounting. Because economists like to economize on effort, the succinct term cost is also frequently used in lieu of opportunity cost or economic cost. In fact, whenever the term cost is used in economics, absent of any modifiers, it generally means opportunity cost.

More Details on Cost
Three phrases in the definition of opportunity cost warrant further discussion--alternative foregone, highest valued, and pursuit of an activity.

Foregone Alternative
Opportunity cost is all about foregone alternatives, about not pursuing an activity. Reading this entry on opportunity cost means not reading a classic novel by F. Scott Fitzgerald (or more realistically not watching an episode of the television show, Brace Brickhead: Medical Detective). Scarce resources have alternative uses. Using resources to satisfy one want or need means they cannot be used to satisfy another. The opportunity cost of foregone alternatives is often illustrated using production possibilities analysis.

Highest Valued
Opportunity cost is not concerned with ALL possible alternatives, only the best alternative, the highest valued alternative that would have been pursued. Unlimited wants and needs means an unlimited number of alternatives exist for every activity undertaken. But opportunity cost is not about every possible alternative, only about the best alternative. The opportunity cost of reading this entry on opportunity cost would be the satisfaction that would have been obtained from Brace Brickhead: Medical Detective, if watching television is the highest valued alternative foregone.

Pursuit of an Activity
Economics is the study of doing things--surfing the web for economic concepts, watching television, eating hot fudge sundaes. More to the point, economics is the study of how scarce resources are used to address society's unlimited wants and needs. The phrase pursuit of an activity specifically means that society is using resources to produce goods that are consumed to satisfy wants and needs. The primary activities pursued in this context are usually production and consumption.