Opportunity Cost: Definition & Real World Examples
- Track Progress
- 0:23 What is Opportunity Cost?
- 1:31 Value: Benefits and Cost
- 2:00 Monetary Value
- 3:45 Value of Time
- 4:16 Opportunity Cost Examples
- 5:51 Lesson Summary
Learn the most important concept of economics through the use of real-world scenarios that highlight both the benefits and the costs of decisions. Opportunity cost is a simple yet powerful principle that reveals how to make the best economic decisions possible, and it explains why people make the choices they do.
What is Opportunity Cost?
The basic economic problem is the issue of scarcity. Because resources are scarce but wants are unlimited, people must make choices. This lesson showcases the most important concept in macroeconomics, which is the concept of opportunity cost. Very simply, everyone has the same amount of hours in a day, but we all make different decisions about what we do, what we choose to buy, and how we spend our time. What determines these choices? Opportunity cost does.
Every time you make a choice, there is a certain value you place on that choice. You might not know it or think about it, but every choice has a value to you. When you choose one thing over another, you're saying to yourself, I value this more than another choice I had.
The opportunity cost of a choice is what you gave up to get it. If you have two choices - either an apple or an orange - and you choose the apple, then your opportunity cost is the orange you could have chosen but didn't. You gave up the opportunity to take the orange in order to choose the apple. In this way, opportunity cost is the value of the opportunity lost.
Value: Benefits and Cost
Value has two parts to it. It has benefits as well as costs. If you choose an apple over an orange, maybe the apple costs less, but maybe you enjoy it more. So, looking at choice in terms of benefits and costs helps you make better economic decisions. To make a good economic decision, we want to choose the option with the greatest benefit to us but the lowest cost.
For example, if we graduate from college and suddenly find ourselves in the job market, there are choices to be made. Let's say that two jobs become available to us. We can either work for Company A or Company B. The job with Company A promises to pay us $20 an hour, while Company B offers to pay us only $10. Based on this information alone, of course most people would choose Company A.
Why? Because Company A is paying a higher salary. But when you look at this kind of a choice in only dollar terms, you're only seeing it from the perspective of the benefits. Let's take that same example, but now we discover that the job for Company A requires a fancy dress suit that will cost you $1,500. You realize that the job with the higher salary may not be worth it to you. Now you're starting to think economically. You're thinking economically when you look at the value of a choice through the eyes of its benefits and costs.
Whatever we choose, the opportunity cost is the value of the choice we could have had. The opportunity cost of working for Company A is the value of what we gave up to take the job. We gave up the value of working for Company B, so that is the opportunity cost of choosing to work for Company A. In this example, we focused more on the monetary costs. The challenge is, most people get stuck evaluating choices only in monetary terms, but there's more to the story.
Value of Time
The value of a choice to you might be in terms of time or in terms of the enjoyment you could have experienced. When Benjamin Franklin originally explained this concept in his book, titled Advice to a Young Tradesman, he said that 'time is money.' He was trying to communicate the concept of opportunity cost by saying that what you do with your time, whether or not you are productive, can be just as important as any decision you make with money.
Opportunity Cost Examples
Here are a few examples:
Let's say you have only $100 to spend and you have two choices: you can eat at a nice restaurant or buy seven music albums instead. If you spend your $100 on buying the albums, the opportunity cost of that choice is the delicious meal you did not choose.
As I already said, this concept works for spending money, but it also works in regards to time. Let's say you only have two hours of free time. You could either go to a movie or visit the bookstore. If you choose to spend your time at the movies, the opportunity cost of this decision is the time you could have spent enjoying the bookstore.
You can apply the concept of opportunity cost to land as well. If we assume that land can either be used to produce corn, or it can be used for raising cattle to produce beef, but it cannot be used to do both at the same time, we have two choices and we must make a decision. Let's say we're already producing corn, but we want to switch to raising cattle so we can produce beef. In this case, the opportunity cost of switching from producing corn to raising cattle is the amount by which the production of corn decreases, because that's the value of our next best alternative.
To summarize what we've talked about in this lesson, scarcity creates choice, and every choice has value to us. That value can be looked at in terms of benefits and in terms of cost. Value is not always measured in financial terms but sometimes measured in terms of time or enjoyment. The opportunity cost of a choice is what must be given up in order to take an opportunity. It's not the opportunity we chose, but the value of the next best alternative we didn't choose. Every major choice has an opportunity cost, and later on, you'll learn how to calculate it.
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Chapters in Economics 102: Macroeconomics
- 1. Scarcity, Choice, and The Production Possibilities Curve (5 lessons)
- 2. Comparative Advantage, Specialization and Exchange (3 lessons)
- 3. Demand, Supply and Market Equilibrium (6 lessons)
- 4. Measuring the Economy (5 lessons)
- 5. Inflation Measurement and Adjustment (10 lessons)
- 6. Understanding Unemployment (5 lessons)
- 7. Aggregate Demand and Supply (7 lessons)
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