What is Opportunity Cost?

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What is opportunity cost and how do you use this concept in managing scarce resources such as money?

The concept of opportunity cost is one of the important foundations of economics. John Stuart Mill, a well-known British philosopher, economist and civil servant developed the idea. This article clarifies this very useful idea that will help one manage scarce resources such as time and money.

What is opportunity cost?

Opportunity cost is defined as the cost of the next-best choice available to an individual given the opportunity to decide. Given a range of options, a person can choose only one from several mutually exclusive choices. Mutually exclusive means that if one is option is chosen, this precludes him from enjoying the benefits of the other options. This illustrates the basic relationship between scarcity and choice. One cannot avail of all goods and services at the same time.

Understanding the idea of opportunity cost can help make an individual make the correct decision when making a choice. Realizing that whatever choice one makes corresponds with some kind of trade off, or loss of something equally valuable to the option taken, leads to well contemplated, rational choice or efficient use of scarce resources. These scarce resources are not only in the form of money but also time, privilege, enjoyment, opportunity or anything desirable or valuable that will make living worthwhile or better than what it used to be.

The value of choice differs between individuals. What is valuable to one person may not be that valuable to another. An individual, therefore, decides according to the maximum possible utility or benefit that could be obtained in making a choice. This tendency suggests that the best approach to decision making is to exhaust all the possible alternatives, weigh the advantages and disadvantages of each option against each other thoroughly before making up one’s mind (see Decision Making Technique for Indecisive People).

Example of Decision Making Using the Opportunity Cost Concept

If you have in your pocket a hundred dollars, how will you spend this bearing in mind the concept of opportunity cost? This prompts you to consider a variety of options say the following list of 5 items that a hundred dollars can buy:

  1. a shoe
  2. a trip to visit your ailing mother
  3. a sumptuous dinner with several of your friends
  4. a month’s supply of fuel to your car
  5. a week’s supply of groceries

This range of choices comes as the individual reflects on the best use of his $100 bill. That is, if he has learnt about the concept of opportunity cost. If he is not aware of the opportunity cost idea, the tendency will be to spend the money at the first opportunity to do so. This is the reason why some people feel bad or regret about their purchases. This just indicates that the best use of money was not made.

What then is the basis for spending for the best use of scarce resources such as money? This varies between individuals as people have different values and circumstances that determine how they spend the money under their disposal. A person in dire need of water in the desert will give up all his gold for a cup of water to quench his thirst.

The conclusion of the matter is that knowledge and understanding of the concept of opportunity cost and how it operates does matter. This is a very powerful idea that will aid one to manage scarce resources wisely.

© 2011 September 27 Patrick A. Regoniel What is opportunity cost?


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