Deciphering Economics: Opportunity Cost Essentials

Assuming the best choice is made, it is the "cost" incurred by not enjoying the benefit that would be had by taking the second best choice available. The New Oxford American Dictionary defines it as "the loss of potential gain from other alternatives when one alternative is chosen".

Opportunity cost is a key concept in economics, and has been described as expressing "the basic relationship between scarcity and choice".  The notion of opportunity cost plays a crucial part in ensuring that scarce resources are used efficiently.

Thus, opportunity costs are not restricted to monetary or financial costs: the real cost of output forgone, lost time, pleasure or any other benefit that provides utility should also be considered opportunity costs.

Explicit costs

 Frederic Bastiat in his essay "What Is Seen and What Is Not Seen".

Opportunity costs in consumption

Opportunity cost may be expressed in terms of anything which is of value. For example, an individual might decide to use a period of vacation time for travel rather than to do household repairs.

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The opportunity cost of the trip could be said to be the forgone home renovation.

Opportunity costs in production

Opportunity costs may be assessed in the decision-making process of production. If the workers on a farm can produce either one million pounds of wheat or two million pounds of barley, then the opportunity cost of producing one pound of wheat is the two pounds of barley forgone (assuming the production possibilities frontier is linear). Firms would make rational decisions by weighing the sacrifices involved.

Explicit costs

Explicit costs are opportunity costs that involve direct monetary payment by producers. The opportunity cost of the factors of production not already owned by a producer is the price that the producer has to pay for them. For instance, a firm spends $100 on electrical power consumed, their opportunity cost is $100. The firm has sacrificed $100, which could have been spent on other factors of production.

Implicit costs

Implicit costs are the opportunity costs in factors of production that a producer already owns.

They are equivalent to what the factors could earn for the firm in alternative uses, either operated within the firm or rent out to other firms. For example, a firm pays $300 a month all year for rent on a warehouse that only holds product for six months each year. The firm could rent the warehouse out for the unused six months, at any price (assuming a year-long lease requirement), and that would be the cost that could be spent on other factors of production.

Non-monetary opportunity costs

Opportunity costs are not always monetary units or being able to produce one good over another.

The opportunity cost can also be unknown, or spawn a series of infinite sub opportunity costs. For instance, an individual could choose not to ask a girl out on a date, in an attempt to make her more interested ("playing hard to get"), but the opportunity cost could be that they get ignored - which could result in other opportunities being lost. Note that opportunity cost is not the sum of the available alternatives when those alternatives are, in turn, mutually exclusive to each other – it is the value of the next best use.

The opportunity cost of a city's decision to build the hospital on its vacant land is the loss of the land for a sporting center, or the inability to use the land for a parking lot, or the money which could have been made from selling the land. Use for any one of those purposes would preclude the possibility to implement any of the other.

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