Understanding The Concept Of Opportunity Cost

September 27, 2017 Haris J

Detailed explanation of the concept of opportunity cost through examples

A key concept in Economics is that of Opportunity Cost. The definition of Opportunity Cost is the benefit of the next best alternative forgone. For instance, if you have 2 hours of free time and you spend them watching TV instead of working on a job, then the opportunity cost of this decision will be the money you have lost for those 2 hours not worked. This is assuming that working for those 2 hours was the next best alternative as compared to watching TV.

In Economics, the benefits of decisions for individuals are ultimately measured in terms of ‘utils’ which can be the measuring unit of utility or satisfaction or happiness. For example, if an individual worked for 2 hours instead, he could have earned, let s say, £50 and so the opportunity cost of watching TV can be the satisfaction he or she could have obtained by spending the earned money on let s say food or a movie in the cinema instead.

Another point to note is that opportunity cost is not the alternative decision itself but instead the benefit or utility of that decision that an individual is forgoing by selecting something else. This the reason that the word cost is used with the word opportunity because an individual making a decision carries a cost which is the utility that he or she could have gained by selecting the next best alternate decision.

Even at a macro level, the concept of opportunity cost should be used. For example, if the government has a budget of £1 million and it chooses to spend on hospitals instead of schools for a society, then the opportunity of this decision would be the returns (higher national income through better educated population) that the government is forgoing.

The study of Economics instils in us to make use of this concept of opportunity cost in our everyday lives, in making our everyday decisions. For example, if the same individual who is spending 2 hours watching TV, the cost for him in making this decision is not just the electricity used by the TV but also the 2 hours’ worth of working time lost that could have earned him money.

As a result, that individual should only make the decision of watching TV if he thinks that the utility gained from watching it for 2 hours will be greater than the utility lost through not earning money for 2 hours and the cost of electricity (money he could have saved to spend somewhere else).

The concept of opportunity cost is a cornerstone in the field of economics and applying this concept in our day-to-day decisions would enable us to make most rational decisions for ourselves i.e. decisions that maximise our utility given the constraint of time and/or money.

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