How are opportunity cost and comparative advantage interlinked? What is mean by opportunity cost? How does opportunity cost influence decisions? Why are they important for free trade? If you think that these questions are worthwhile, then, let’s begin to explore the answers through “Explaining the concept opportunity cost.”
Opportunity cost: meaning and example
In our daily activities, many a times, you might have encountered with various products you purchased or sold out. These products have printed price tags and interested person has to pay or receive it. But, in economics perspective, the price that is printed isn’t actual cost because it isn’t with the costs that you are going to lose when you go for it.
Actually, the cost of product you are purchasing is something more than the printed one. It includes costs of opportunities that you might have enjoyed if you think otherwise. Simply, opportunity cost is a potential cost that a person sacrifices if the person thinks to purchase anything.
Opportunity cost is a fundamental concept in economics that refers to the value of the next best alternative that is sacrificed when a decision is made. It emphasizes the trade-offs that individuals and businesses must consider in their decision-making processes. By understanding opportunity cost, one can better evaluate the potential benefits of various choices and recognize what is forfeited by selecting one option over another.
Examples of opportunity cost
Example 1
Suppose, David is a 10th class student. On holiday, he does part time job to distribute newspapers. By doing so, he earns $50 per week. One day, he instead job, goes to watch a circus. As he reach there, he notices many children enjoying. Today, he has $100 and he has to manage ticket, fare, and snacks. Ticket is of $65 and he needs some $30 for fare. Finally, it remains only $5 for snacks.
Generally, he loves to have sea food. But, now, he has only $5 for snacks and so, can’t afford. At last, after some brainstorming, he goes to enjoy circus show. In this way, he sacrifices the desire to have sea food, and prefers to watch show. If he had more money, David would have definitely enjoyed his favorite sea food on special occasion.
In another one possibility, had he thought to watch movie, instead of circus, he might have enjoyed his favorite snacks. “So, to watch circus, David pays much more than the actual cost of ticket. He pays cost of ticket + cost of fare + cost of satisfaction that he would have experienced, if he had more dollars”
Example 2
Consider an individual who has the option to either attend college or start working immediately after high school. If the individual chooses to attend college, the opportunity cost includes the wages that could have been earned during those years of employment. Additionally, the costs associated with tuition, books, and living expenses are also part of the opportunity cost. Therefore, the decision to pursue higher education entails evaluating not just the immediate financial investment but also the potential income lost during those years.
Example 3
In business, suppose a company has a budget of one million dollars that can either be invested in a marketing campaign or used to upgrade machinery. If the business opts for the marketing campaign, the opportunity cost entails the potential efficiency gains and long-term savings that could have been realized from the upgraded machinery. By assessing these trade-offs, companies can make informed decisions that align with their goals and improve resource allocation.
Importance of opportunity cost
This concept opportunity cost underpins essential economic ideas such as scarcity, choice, and resource allocation. In an environment where resources are limited, individuals and organizations must constantly evaluate trade-offs in order to optimize their outcomes.
Scarcity–choices–opportunity cost–comparative advantage–specialisations–economies of scale–free trade system..
So, the principle of opportunity cost is directly linked to the notion of scarcity. Since resources such as time, money, and labor are limited, the choices we make come at a price. Therefore, every decision, whether in personal finance, business investment, involves weighing the potential benefits of one option against the missed opportunities associated with others. Failure to consider opportunity costs can lead to inefficient decision-making. And, it may result in loss of potential gains and wasted resources.
In short, opportunity cost is an essential principle in economics that influences our decision-making processes. By recognizing the significance of opportunity cost, individuals and organizations can better navigate their choices, leading to more efficient and effective outcomes.
Finally, opportunity cost is not merely an abstract economic principle but a practical tool that can guide day-to-day choices. By actively assessing what is sacrificed when selecting one option over another, individuals can enhance their decision-making skills in areas ranging from personal finance to professional growth.The law of demand and supply/The idea of invisible hand