Opportunity Cost
The value of the best alternative forgone when making a choice — the fundamental concept of economic scarcity.
Opportunity cost is the value of the best alternative given up when a choice is made. Because resources are scarce — time, money, labor, and capital are limited — every decision has a cost, and that cost is not the money spent but the best thing not done instead. The concept is the foundation of economics: if there were no scarcity, there would be no choices to weigh and no opportunity costs.
The cost of attending a university year includes tuition and books, but also the salary forgone by not working — often the larger part. A business that invests in a new factory foregoes the return it could have earned on other investments. Opportunity cost applies to government too: spending on a program uses resources that could have served elsewhere, and the true cost is measured in the alternative. Because costs are measured this way, economists count only the best forgone alternative, not every alternative.
Opportunity cost also distinguishes explicit from implicit costs. Explicit costs are out-of-pocket payments; implicit costs are the value of owned resources used in the venture — an entrepreneur's own time, a building already owned. Economic profit subtracts both from revenue; accounting profit subtracts only explicit costs, which is why a business can be accounting-profitable yet economically unprofitable.
The idea organizes microeconomic reasoning. The production possibility frontier — the curve of all efficient output combinations of two goods — derives its bowed shape from rising opportunity costs: as more of one good is produced, ever more of the other must be sacrificed. Prices in competitive markets, as analyzed in supply and demand, move to equalize opportunity costs across uses. In decision-making, the practical rule is: ignore sunk costs (already incurred, unrecoverable) and weigh only what the next best option would have delivered.
Tags
decision making economics microeconomics scarcity
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