An Introduction to Opportunity Cost
Ten years from now, if you are asked about the most important lesson you learned in economics class, the answer should be opportunity cost. Opportunity cost is the value of the next-best alternative when you make a decision; it's what you give up. Understanding opportunity cost allows you to make decisions, knowing both what you are getting and what you are giving up.
Let's consider our first life question.
|Would you rather go to a movie or go to a baseball game?|
What do movies and baseball games have to do with opportunity cost? Well, if you have a free evening and go to the baseball game, you can't spend that evening watching a movie. The movie is your opportunity cost; it's what you gave up. Likewise, let's say you have fifty cents and can either buy a candy bar or a pack of gum. If you buy the gum, what's your opportunity cost? It's the candy bar.
Opportunity cost is the value of the alternative you didn't choose; generally speaking, this is the next-best alternative. So, the opportunity cost is NOT the money spent, it is the next-best thing your money could have bought—the candy bar!
Clearly, life has tougher choices than candy and baseball, but these examples illustrate that every decision has an opportunity cost, small or large.
Let's consider another life question.
|Would you rather lend $100 to your brother or buy a $100 pair of jeans?|
Understandably, some people would never lend money to a brother, but let's assume your brother is cool. He's loaned you money in the past, and you know he'll pay you back. He asks to borrow $100 so that he can pay his car insurance this month. If he doesn't have insurance, he can't drive. If he can't drive, he can't get to work to earn money to pay his car insurance. You can see his dilemma. So, you lend him $100 with the stipulation that he pay you back in two months. One month later, you find your favorite jeans on sale for only $50. That's half off! You could get two pair for the price of one! You ask your brother to pay you the $100, but he doesn't have it. He reminds you that the agreement was that he would pay you back in two months, not one. Meanwhile, you miss the denim deal of a lifetime.