Definition of opportunity cost

The Basic Economic Problem – Opportunity Cost

Learning Objective

Define opportunity cost and understand its significance in economic decision‑making.

Definition

Opportunity cost is the value of the next best alternative that must be given up when a choice is made. In other words, it is what you sacrifice in order to obtain something else.

Key Points to Remember

• Resources (time, money, labour, capital) are scarce.
• Every choice involves a trade‑off.
• The opportunity cost is always measured in terms of the most valuable forgone alternative.
• It is a central concept for both micro‑ and macro‑economics.

Simple Formula

The opportunity cost of a decision can be expressed as:

\$\text{Opportunity Cost} = \text{Benefit of the Next Best Alternative} - \text{Benefit of the Chosen Option}\$

Illustrative Example

Suppose a student has 4 hours of free time after school. They can either:

1. Study for an upcoming exam and potentially raise their grade by 5 marks.
2. Work a part‑time job earning $20.

If the student chooses to study, the opportunity cost is the $20 they could have earned by working. Conversely, if they work, the opportunity cost is the 5‑mark improvement they forfeit.

Table: Comparing Two Alternatives

Why Opportunity Cost Matters

Understanding opportunity cost helps individuals and firms allocate scarce resources efficiently, maximise welfare, and make informed choices about production, consumption, and investment.