The concept of "opportunity cost" is one of the foundations of economics, whether macroeconomics or microeconomics. When we make a decision - any decision - we give up an alternative choice. Whatever we give up or lose in this alternative decision is the opportunity cost. Think of this as a missed opportunity. Many decisions - especially decisions concerning "economics" - usually involve time and/or money - both are resources, and both are scarce or limited. We have only so much money to spend and we have only 24 hours in a day.
A simple example of opportunity cost is this: I decide to spend the day at the mall to buy a new outfit. What am I giving up? I am giving up 8 hours of time that could be spent doing something else and whatever money ($200?) for a new outfit. The opportunity cost of this trip to the mall would be the best alternative to these acts. Is there a better way to use this day? Is there a more productive way to spend $200? Perhaps the best alternative would be to spend that day working on my homework for ECO202, or earning money in a part time job, or spending quality time with my family. The $200 might be better off invested in an account that earns interest, or spent on food for my family or put towards a credit card bill. If I am to make the best and most economical decision, I have to weigh opportunity costs (as well as any marginal costs).
Please answer the following questions (in two separate posts):
- Think of an example in your personal life where the concept of opportunity cost plays (or should play) an important role in your decision making. What are the opportunity costs and benefits of your decision?
- Now, imagine you are a manager for a small business or firm (you decide the type of business). You have an extra $5,000 in the budget to spend. How do you decide how to spend this money? How do you use the concept of opportunity cost to make this decision?