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Understanding Opportunity Cost

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What is opportunity cost? 

Opportunity cost is a common term in economics, but what does it mean?  People tend to throw this term around frequently, yet many people tend to struggle with it.   

An Abstract Idea 

While the idea of opportunity cost can seem abstract, at its core it’s a pretty basic principle.  Essentially, it’s the benefit you could have received but gave up for something else.  The opportunity cost formula is often expressed as: 

Opportunity Cost = Benefit of Alternative Option – Benefit of Option Chosen 

An Example 

So, what are some examples of opportunity costs in our everyday lives?  Let’s say you have two choices.  Choice A is to meet some friends for dinner after work.  Choice B is to go see a movie with your significant other.   

To calculate the opportunity cost you would assign a value to each option.  In this case, the benefit is to increase your quality of life.  I’ll call these measurements QOL for short.   

Going out with friends would be a lot of fun.  You haven’t seen them in a while and they are going to a new restaurant.  So, meeting your friends with Choice A would increase your QOL by 5. 

But, a movie with your significant other would also be a great time.  There’s a reason that person is your significant other, you clearly enjoy spending time with them, and you do like seeing movies.  So, Choice B would increase your QOL by 6. 

If you chose Choice A your opportunity cost would be 1 QOL. 

Opportunity Costs are Everywhere 

Now that you understand how to calculate opportunity cost, it’s easy to see them throughout your everyday life.  Picking one stock over another is an opportunity cost.  Deciding to work overtime has costs associated with it as well.  Now, this isn’t to say that you should be bogged down in which is the best decision all the time.  But, before you make a big decision, just remember to weight the opportunity costs. 

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