Opportunity Cost


Time value of money

Opportunity cost is the value of the next best thing after making a decision; the utility of the decision has to outweigh the opportunity cost for it to be a good choice.

For example, opportunity cost describes leisure time given up to work, because leisure and income are both valued. Going to work implies more income but less leisure.

Opportunity cost is a key concept in economics, and has been described as expressing ‘the basic relationship between scarcity and choice.’ It plays a crucial part in ensuring that scarce resources are used efficiently. This is why opportunity costs are not restricted to financial costs: the real cost of output forgone, lost time, pleasure or any other benefit that provides utility are also considered opportunity costs. In a restaurant situation, the opportunity cost of eating steak could be trying the salmon. The opportunity cost of ordering both meals is a lighter wallet and a heavier midsection. A family might decide to use a short period of vacation time to visit Disneyland rather than doing household improvements. The opportunity cost of having happier children could therefore be a remodeled bathroom.

In environmental protection, opportunity cost is also applicable. This has been demonstrated in the legislation that required carcinogenic compounds to be largely eliminated from gasoline. Unfortunately, this required refineries to install equipment at a cost of hundreds of millions of dollars – and pass the cost to the consumer. The absolute number of cancer cases attributed to exposure to gasoline, however, is low, estimated a few cases per year in the US. Thus, the decision has been criticized on the grounds of opportunity cost: the hundreds of millions of dollars spent on process redesign could have been spent on other, more fruitful ways of reducing deaths caused by cancer or automobiles.

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