Opportunity Cost is the next best alternative foregone. In simple words, when you choose to do one thing, you have to let go of something; the thing that you let go of is the opportunity cost of the thing you are doing. For example, you have $10, and you have two ways you can spend the money: either buy an ice cream or buy a toy. If you choose to buy the ice cream, the opportunity cost is the toy that could have been bought with the money.

Influence of Opportunity Cost on Decision Making

Opportunity Cost and Consumers: Consumers are buyers of goods and services, and we cannot buy everything we like due to limited money. So we have to choose between the goods to buy. The choice becomes increasingly harder the more the quality and price of the two goods become the same.

Opportunity Cost and Workers: Choosing one job requires an opportunity cost. People need to carefully consider their preferences for the jobs available. This would be influenced by a number of factors, including the wage paid, chances of promotion, and the job satisfaction to be gained from each job.

Opportunity Cost and Producers: Producers have to decide what to make. In deciding what to produce, private sector firms will tend to choose the option that will give them the maximum profit. They will also take into account the demand for different products and the cost of producing those products.

Opportunity Cost and Government: The government has to carefully consider its expenditure of tax revenue on various things. If it decides to spend more on education, the opportunity cost involved may be a reduced expenditure on healthcare. It could, of course, raise tax revenue in order to spend more on education. In this case, the opportunity cost would be borne by the taxpayers. To pay higher taxes, people may have to give up the opportunity to buy certain products or to save.

Economic and Free Goods: Economic goods have an opportunity cost, but free goods don’t.

Definition 

Opportunity cost – Next best alternative foregone

Summary

• Opportunity cost is an important concept as it emphasises that people have to consider what they are sacrificing when they decide what to buy, what job to do, what to produce, and when governments are deciding what to spend their tax revenue on.

• Economic goods have an opportunity cost, whereas free goods do not.

Written by Trishiv Ohlan

Content supplied by Mara