Definition
Per Fernando (2025) everyone faces trade offs - whether you think about it or not, there is always a cost that you forgo, may that be different courses of action, investments, or uses of our time and resources. Choosing one option means giving up the potential benefits or opportunities of another. This is because resources are scarce. This is where opportunity cost comes into play.
The opportunity cost of a choice is the value of the best alternative forgone.
Per Gans et al. (2021) in economics, the cost of something is therefore:
explicit cost (out of pocket expense) + implicit (opportunity cost). Read more here.
Why It Matters
By understanding the explicit and implicit costs of a decision, you can make a more informed decision, whether it’s investing related, or just a daily activity.
Example
An example includes Carol who must decide how to allocate her time. For every hour she spends studying one subject she could be working, bike riding, or watching YouTube- that is her opportunity cost.
Limitation
Opportunity cost is very subjective and works on assumptions. (K)
Another Example
Another example includes a clean environment vs high level of income:
In modern society is the trade-off between a clean environment and a high level of income - laws that require firms to reduce pollution usually raise the cost of producing goods/services. Because of these higher costs, these firms earn smaller profits, pay lower wages, charge higher prices or a combination of these. Whilst pollution regulations give us a cleaner environment, it comes at the cost of reducing the wellbeing of owners, workers, and customers.
Work cited:
Fernando, Jason. “Opportunity Cost: Definition, Calculation Formula, and Examples.” Investopedia, 31 May 2025, www.investopedia.com/terms/o/opportunitycost.asp.
Gans, Joshua, et al. Principles of Microeconomics. South Melbourne, Victoria, Australia, Cengage Learning Australia, 2021.
K, Sanjeed V. “Opportunity Cost: What Is It and How Does It Affect Business Decisions?” Wise, 19 Dec. 2024, wise.com/sg/blog/opportunity-cost.
