Opportunity Cost
Definition
Opportunity cost is defined as the best alternative forgone. It represents what you give up when
choosing one option over another. It highlights the trade-offs inherent in choices.
Key Concepts
Scarcity: Opportunity cost arises because resources are scarce, forcing choices. Land, labor,
capital, and enterprise are scarce, so decisions have to be made about the method and
purpose of their use.
Trade-offs: Every decision involves trade-offs; selecting one option means losing the benefits
of others.
To ensure that we make the right decisions, it is important that we consider the alternatives,
particularly the best alternative.
Influence on Decision-Making
Opportunity cost is an important concept as it emphasises that people should consider what
they are sacrificing when they make a decision.
Consumers
Consumers are buyers and users of goods and services.
Opportunity cost affects purchasing decisions, influencing choices between goods and
services based on perceived value.
Consider what else you could buy with the same money.
Example: Buying a phone means foregoing other goods/services you could have purchased
with that money.
Workers
Opportunity cost impacts career choices, education investments, and labor supply decisions.
Evaluate the potential earnings and benefits of different job options.
Take into account the wage paid, chances of promotion, and the job satisfaction.
Example: Choosing to work means foregoing leisure time.
If the pay or working conditions of an alternative job improve, the opportunity cost of the
current job will increase.
Producers/Firms
Opportunity cost guides production decisions, influencing resource allocation and what to
produce.
Assess the profitability of producing different goods or services.
Private sector firms will tend to choose the option which will give them the maximum profit by
paying attention to the demands of different products and the cost of producing those
products.
Example: Using resources to produce one product means not producing another. If a farmer
uses a field to grow oilseed, they cannot keep cattle on that field.
Governments
Opportunity cost shapes government spending priorities, impacting resource allocation
across different sectors (e.g., defense, education, healthcare).
Weigh the benefits of public spending projects against alternative uses of tax revenue.
Government has to carefully consider its expenditure of tax revenue on various things.
Example: Spending on education means less spending on healthcare (or other sectors).
Raising taxes to fund spending shifts the opportunity cost to taxpayers. Higher taxes may
force individuals to reduce consumption or savings.
Economic Goods vs. Free Goods
Economic Goods:
Produced using scarce resources.
Production involves an opportunity cost (something is forgone).
Free Goods:
Do not require resources to produce.
No opportunity cost.
Example: air
