Opportunity cost: definition and meaning

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There is no doubt that resources are limited. This scarcity of resources often makes the lives of decision makers very difficult. Therefore, economists focus on the optimal use of scare resources. Whenever there is scarcity, you need to make a choice. If you have £10, you can perhaps spend it on buying an economic textbook, or enjoying a meal in a restaurant. You cannot do both!

Definition of opportunity cost

Opportunity cost is one of the most fundamental ideas in economics. It refers to ‘the cost of a scarce factor of production used to produce a good or service, as opposed to another which could have been used instead of the one adopted. It is also called economic cost’ (Bateman, McAdam, 2006, p.148).

According to Watts (2008) opportunity cost is another way of determining the true and full cost of any activity by considering the value of the next-best alternative that was traded off or forsaken in the course of selecting the chosen activity.

To put it in the simplest way, opportunity cost is the cost of giving up one thing in favour of something else (Financial Times, n.d.). When you take a course of action, you use resources e.g. time and money that cannot be used in other activities. The opportunity cost is the value of those foregone opportunities (Nielsen, 2004).

Importance of understanding opportunity cost

Opportunity cost is a reminder for you to assess all the reasonable alternatives before making a decision. For instance, you need to visit a friend living in a city far away from yours. Let’s say the cost of flying (plane ticket) to the city is £300 whereas £100 (gas/patrol) for self-drive. In light of these figures, it is more rational and economical to drive than fly.

However, this conclusion can be contested. For example, say you are a highly paid employee of a multinational organisation. And it takes 10 hours to drive to the city, while 2 hours to fly. As a highly paid employee, you are better off working some extra hours. You can then fly! So, it can be argued that flying is the best alternative for you.

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Last update: 07 September 2018

References:

Bateman, H. & McAdam, K. (2006) Dictionary of economics, 1st edition, London: A & C Black Publishers Ltd

Financial Times (n.d.) Definition of Opportunity cost, available at: http://lexicon.ft.com/Term?term=opportunity-cost (Accessed 07 September 2018)

Watts, B. (2008) Journal of multi disciplinary evaluation, Volume 5, Number 10

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Author: M Rahman

M Rahman writes extensively online with an emphasis on business management, marketing, and tourism. He is a lecturer in Management and Marketing. He is a graduate of both Leeds Metropolitan University and London South Bank University.