1. What is Opportunity Cost
2. Opportunity Cost in Economics
3. Key Factors of Opportunity Cost
4. Types of Opportunity Cost
5. Opportunity Cost Examples
Opportunity Cost Definition
Types and 4 Examples
WRITTEN BY PAUL BOYCE | Updated 6 November 2020
What is Opportunity Cost
If you are here, its probably because other explanations of opportunity cost are unnecessarily hard to read. As an economist, it is easy enough to get carried away with economic jargon rather than focusing on the audience. So that is what I will do below.
- Opportunity cost is the cost of taking one decision over another. This cost is not only financial, but also in time, effort, and utility.
- Opportunity cost can lead to optimal decision making when factors such as price, time, effort, and utility are considered.
- Its necessary to consider two or more potential options and the benefits of each. Some may place greater value on time, whilst others on price.
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What is Opportunity Cost in Simple English?
Opportunity cost is the cost of making one decision over another that can come in the form of time, money, effort, or utility (enjoyment or satisfaction). We make these decisions every day in our lives without even thinking.
Opportunity cost is the cost of making one decision over another. That can come in the form of time, money, effort, or utility.
When we make a purchasing decision, we subconsciously consider several factors before making a decision. However, because we make so many decisions every day, our brain stores previous decisions we made and uses them to help speed up the decision process. Our brains simultaneously consider factors such as time, effort, and money. This then allows us to come to a decision which best optimizes how much we value each of these factors.
Example of Opportunity Cost
A consumer may purchase a croissant on the way to work. They choose this over having breakfast at home or sitting down in a restaurant for a full breakfast. A croissant is cheaper than a restaurant lunch but more expensive than breakfast at home. Yet consumers dont sit down thinking about this decision for hours or days. These are decisions taken in minutes or seconds.
When the consumer buys a Croissant, they forego $2, or however much it costs. The opportunity cost is what could have been brought instead of a Croissant. This could be a bottle of Cola, a Pretzel, or some French Fries.
When considering opportunity cost, it is also important to consider utility, which is essentially, how much pleasure/enjoyment the individual gets. So whilst the Croissant saves time and effort, it costs more than breakfast at home and gives the consumer lower satisfaction than a full breakfast.
What is Meant by Opportunity Cost in Economics?
Opportunity cost requires trade-offs between two or more options. One is chosen and the others are foregone. In economics, it is assumed that this chosen option is the most valued and most optimal. So when a consumer purchases a Starbucks, its value is greater than the $5 paid for it. The value that the consumer receives is known as the consumer surplus, which is simply the additional value they receive from consuming the product below their willingness to pay. .
Economists often refer to the opportunity cost as the next best alternative that is foregone. That may be getting a Black Coffee instead of a Latte. To the consumer, a Black Coffee may be the second-best alternative.
Just think of a time when you went into a store and they did not have the item you want in stock. You may very well choose a close substitute instead. This is the next-best product but is one that you usually forego. This is generally considered as the opportunity cost but is commonly considered using four variables.
4 Key Factors of Opportunity Cost
When making decisions, there are four common factors that we consider. These are:
Perhaps one of the biggest factors is the price; although this can vary depending on income. Those will lower levels of income are more likely to place more emphasis on price as part of the opportunity cost. Eating breakfast at home, for example, is cheaper. As a result, this would be a more favorable option due to the pricing. By comparison, a billionaire is unlikely to value price as high as the three other factors.
Everyone has the same 24 hours in a day. Whether youre Bill Gates, Warren Buffett, or your next-door neighbor. So each purchasing decision taken bears this in mind. For instance, it may be $0.50 cheaper to go to the store down the road, but is it worth the extra 10 minutes?
If you are currently working for a wage of $15 an hour; saving yourself $0.50 for 10 minutes may seem illogical. Nevertheless, it is up to the individual to value their time accordingly based on each individual scenario.
Time and effort are essentially interlinked. For instance, it may take time to go to your favorite restaurant, but also the effort of driving or walking there. So you may choose a local one that isnt as good in order to save time and effort. In addition, you may be able to find a cheaper deal on the internet but would require you to devote time and effort.
This is essentially the enjoyment or pleasure that the consumer receives. This is perhaps one of the most important factors. Consumers all want to maximize their utility, but are limited by other factors such as time and price.
For example, consumers may want a 2 week holiday in the Caribbean, but have to consider whether they can still pay the bills. As incomes rise, the influence of utility becomes ever greater, whilst the impact of price diminishes.
Types of Opportunity Cost
Explicit Opportunity Cost
An explicit cost is a cost made as a direct payment in cash. This can include an employees wages, rent, or raw materials. So when looking at explicit opportunity costs, this covers what could have been used on a monetary basis. That is to say, what else could-have-been brought with that money?
For example, let us say that a business hires a new employee on a wage of $40,000 per year. When it employs that person, it foregoes $40,000 each and every year they are employed.
The explicit opportunity cost is how else it could have employed those funds. This could be updated machinery, a marketing campaign, or a bonus for its employees. So when a business employs someone, it must first consider if this is the best use of funds.
Implicit Opportunity Cost
An implicit cost is a cost that has already occurred. This covers assets that have already been purchased such as land, a factory, or machinery. As opposed to explicit costs; implicit costs refer to how a purchased asset is used after its purchase, rather than before.
Implicit opportunity costs refer to the variable options that can be pursued in order to make use of an asset. For example, a business owns a factory. It could use it to either manufacture motor vehicles, tinned fruit, or maybe even computing equipment.
When deciding how best to use the factory, it must consider the opportunity cost of not pursuing the other options. Most likely, it will choose what will make it the most profitable.
Opportunity Cost Examples
PriceTimeEffortUtilityPossible AlternativesChosen your favourite restaurant 30 min drive away$10 more than eating at home30 minsHaving to drive for 30 minsMaximised utility as its your favourite restaurantEat at home or get a takeawayGrab a Starbucks Coffee on the way to work$5 more than getting one free at work5 mins waiting in lineHaving to wait in a lineMaximised utility as its better than the one at workCoffee before work, coffee at work, or forego coffee altogetherStay at home for dinnerMuch cheaper than alternatives, potentially saving $10 over eating outPerparation and cooking time may tak 30-60 minsHaving to cook and clean upLow level of utlity, although there may be a sense of achievement for cooking a nice mealEating out or grab a takeawayChoose the Supermarkets own-branded cerealMuch cheaper than branded alternative, perhaps saving $2No time savings or costNo more effort requiredLow level of utility as the own-brand may not taste as goodBranded cereal or other breakfast substitute
General FAQs on Opportunity CostWhat is opportunity cost simple definition?
Opportunity is the cost of making one decision over another. That cost can come in the form of time, money, effort, or utility (essentially enjoyment or satisfaction). We make these decisions every day in our lives without even thinking.What is opportunity cost and what does it mean for you?
Opportunity costs refer to the trade-offs between two or more options/decisions. It is assumed that the chosen option is the most valued. So when you buy a coffee from Starbucks in the morning; this is of greater value than the $5 you paid.What is an example of opportunity cost in your life?
For example, we may purchase a Croissant on the way to work. We choose this over having breakfast at home or sitting down in a restaurant for a full breakfast. A croissant is cheaper than a restaurant lunch but more expensive than breakfast at home. We dont sit down thinking about this decision for hours or days. These are decisions we take in minutes or seconds.What does opportunity cost include?
Opportunity cost includes the decision taken between two or more options. The cost is the price paid for choosing one option over another.
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