Opportunity cost

Benefit lost by a choice between options / From Wikipedia, the free encyclopedia

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In microeconomic theory, the opportunity cost of a particular activity is the value or benefit given up by engaging in that activity, relative to engaging in an alternative activity. More effectively it means if you chose one activity (for example, an investment) you are giving up the opportunity to do a different option. The optimal activity is the one that, net of its opportunity cost, provides the greater return compared to any other activities, net of their opportunity costs. For example, if you buy a car and use it exclusively to transport yourself, you cannot rent it out, whereas if you rent it out you cannot use it to transport yourself. If your cost of transporting yourself without the car is more than what you get for renting out the car, the optimal choice is to use the car yourself. In basic equation form, opportunity cost can be defined as: "Opportunity Cost = (returns on best Forgone Option) - (returns on Chosen Option)."[1] The opportunity cost of mowing one’s own lawn for a doctor or a lawyer (who might otherwise make $100 an hour if they elected to work overtime during that time instead) would be higher than for a minimum-wage employee (who in the United States might earn $7.25 an hour), which would make the former more likely to hire someone else to mow their lawn for them.

As a representation of the relationship between scarcity and choice,[2] the objective of opportunity cost is to ensure efficient use of scarce resources.[3] It incorporates all associated costs of a decision, both explicit and implicit.[4] Opportunity cost also includes the utility or economic benefit an individual lost, if it is indeed more than the monetary payment or actions taken. As an example, to go for a walk may not have any financial costs imbedded in to it. Yet, the opportunity forgone is the time spent walking which could have been used instead for other purposes such as earning an income.[3]

Time spent chasing after an income might have health problems like in presenteeism where instead of taking a sick day one avoids it for a salary or to be seen as being active. A production possibility frontier shows the maximum combination of factors that can be produced. For example, if services were on the x-axis of a graph and there were to be an increase in services from 20 to 25, this would lead to an opportunity cost for the goods that are on the y axis, as they would drop from 21 to 16. This means that as a result of the increase in consumption of services, the opportunity cost would be those 5 goods that have decreased.[5] Regardless of the time of occurrence of an activity, if scarcity was non-existent then all demands of a person are satiated. It is only through scarcity that choice becomes essential, since the use of scarce resources in one way prevents its use in another way, resulting in the need to make a selection and/or decision.[2] These decisions are in turn exposed to multiple choice outcomes.[6]

Sacrifice is a given measurement in opportunity cost of which the decision maker forgoes the opportunity of the next best alternative.[7] In other words, to disregard the equivalent utility of the best alternative choice to gain the utility of the best perceived option.[8] If there are decisions to be made that require no sacrifice then these are cost free decisions with zero opportunity cost.[9] Through the analysis of opportunity cost, a company can choose a path where the actual benefits are greater than the opportunity cost, so that limited resources can be optimally allocated to achieve maximum efficiency. When choosing an option among multiple alternatives, the opportunity cost is the gain from the alternative we forgo when making a decision.[10] In simple terms, opportunity cost is our perceived benefit of not choosing the next best option when resources are limited.[11] Opportunity costs are not limited to monetary or financial costs.[12] The actual cost of lost time, lost production, or any other for-profit benefit shall also be considered an opportunity cost.[12] Opportunity cost is a key concept in economics, described as the fundamental relationship between scarcity and choice.[11]