Opportunity Cost

… a core concept in Economic Analysis and Atlas102

OpportunityCost3Concept description

Investopedia (reference below) defines opportunity cost as the cost of an alternative that must be foregone in order to pursue a certain action.

The Economist (reference below) describes the opportunity cost, or the true cost, of something as what you give up to get it.

The Economist adds:

“This includes not only the money spent in buying (or doing) the something, but also the economic benefits that you did without because you bought (or did) that particular something and thus can no longer buy (or do) something else. For example, the opportunity cost of choosing to train as a lawyer is not merely the tuition fees, price of books, and so on, but also the fact that you are no longer able to spend your time holding down a salaried job or developing your skills as a footballer. These lost opportunities may represent a significant loss of utility. Going for a walk may appear to cost nothing, until you consider the opportunity forgone to use that time earning money. Everything you do has an opportunity cost. Economics is primarily about the efficient use of scarce resources, and the notion of opportunity cost plays a crucial part in ensuring that resources are indeed being used efficiently.”

David Henderson, in The Concise Encylopedia of Economics (reference below), describes opportunity cost as the value of the next highest use.

Henderson writes:

“If, for example, you spend time and money going to a movie, you cannot spend that time at home reading a book, and you cannot spend the money on something else. If your next-best alternative to seeing the movie is reading the book, then the opportunity cost of seeing the movie is the money spent plus the pleasure you forgo by not reading the book.

“The word “opportunity” in “opportunity cost” is actually redundant. The cost of using something is already the value of the highest-valued alternative use. But as contract lawyers and airplane pilots know, redundancy can be a virtue. In this case, its virtue is to remind us that the cost of using a resource arises from the value of what it could be used for instead.

“This simple concept has powerful implications. It implies, for example, that even when governments subsidize college education, most students still pay more than half of the cost. Take a student who annually pays $4,000 in tuition at a state college. Assume that the government subsidy to the college amounts to $8,000 per student. It looks as if the cost is $12,000 and the student pays less than half. But looks can be deceiving. The true cost is $12,000 plus the income the student forgoes by attending school rather than working. If the student could have earned $20,000 per year, then the true cost of the year’s schooling is $12,000 plus $20,000, for a total of $32,000. Of this $32,000 total, the student pays $24,000 ($4,000 in tuition plus $20,000 in forgone earnings). In other words, even with a hefty state subsidy, the student pays 75 percent of the whole cost. This explains why college students at state universities, even though they may grouse when the state government raises tuitions by, say, 10 percent, do not desert college in droves. A 10 percent increase in a $4,000 tuition is only $400, which is less than a 2 percent increase in the student’s overall cost.

“What about the cost of room and board while attending school? This is not a true cost of attending school at all because whether or not the student attends school, the student still has expenses for room and board.”

Atlas topic, subject, and course

The Study of Economics (core topic) in Economic Analysis and Atlas102 Economic Analysis.

Sources

Investopedia, Opportunity Cost, at http://www.investopedia.com/terms/o/opportunitycost.asp, accessed 4 May 2016.

The Economist, Economics A-Z, Opportunity cost, at http://www.economist.com/economics-a-to-z/o#node-21529616,

David R. Henderson, Opportunity Cost, The Concise Encyclopedia of Economics, at http://www.econlib.org/library/Enc/OpportunityCost.html, accessed 4 May 2016.

Page created by: Ian Clark, last modified 4 May 2016.

Image: Investopedia, minute 00.07 of video,at http://www.investopedia.com/terms/o/opportunitycost.asp, accessed 4 May 2016.