Sign up to access the complete lesson and track your progress!
Unlock This Course
Pick one, lose the other: the next best choice you give up is your opportunity cost
Because resources are scarce, every choice means giving something up. Economists want to know exactly what is given up, because that is the true cost of the choice. This is called opportunity cost.
Key terms:
The important words are next best. You may have five things you could do with an afternoon, but you can only do one. The opportunity cost is the single best thing you did not do, not all of the others added together.
Imagine Amir has $30. He could buy a pair of trainers, a ticket for a football match, or a new phone case. He prefers the trainers first, then the match ticket, then the phone case. He buys the trainers. His opportunity cost is the match ticket, because that was his next best choice. The phone case does not count.
Opportunity cost is not only about money. It can be time, land, workers or machines. Here are three different contexts:
A farmer in Kenya has one field. Growing maize means the field cannot grow beans. If beans were the next best use, the lost bean harvest is the opportunity cost.
Priya spends Saturday morning at a swimming club. She could have worked in her uncle's shop. The pay she gave up is the opportunity cost.
A country spends $50 million on a new airport. It cannot also spend that $50 million on rural schools. The schools it would have built are the opportunity cost.
In every case something real is lost. Opportunity cost shows that nothing is truly free when resources are scarce.
Choosing to build a hospital means giving up the next best use of that money and land
Everyone who has to allocate scarce resources compares the benefit of a choice with what must be given up. If the opportunity cost is high, the choice looks less attractive. If it is low, the choice looks better. Here it is for four decision-makers.
A consumer has limited income. Mei has $40 left this month. She can spend it on a meal out with friends or on a book. She decides the meal is worth more to her, so the book is her opportunity cost. If the book were suddenly on sale for $5, the choice might change. Consumers choose the option that gives them the most satisfaction for the resources they have.
A worker has a limited amount of time. Carlos is offered extra hours on a Sunday for $60. His opportunity cost is the free time he gives up, such as playing football with his family. If the pay rises to $120, the reward is bigger compared with what he gives up, so he is more likely to say yes. Studying also has an opportunity cost: the wages a student could have earned in a full-time job.
A firm has limited land, machines, workers and money. Delta Bikes, a made-up firm, has one factory. It can make 500 mountain bikes or 800 city bikes a month, but not both. If it chooses mountain bikes, the opportunity cost is the profit it would have made from the city bikes. Firms usually choose the use of resources that earns the most.
A government has a limited budget raised from taxes. The made-up country of Zelmar has $200 million to spend. It could build a hospital, a motorway or a school programme. If it builds the hospital, the next best use, say the school programme, is the opportunity cost. Governments weigh up the benefits to citizens of each option, so opportunity cost helps explain why one project goes ahead and another waits.
A bakery owner in a made-up country has one oven for the day. She can make a profit of $120 from bread, $90 from cakes or $60 from biscuits. She bakes bread. Opportunity cost = the cakes, worth $90 in profit, the next best alternative. It is not $90 + $60 = $150, because only the next best alternative counts.
Many students confuse cost with price. Price is the amount of money paid for something. Opportunity cost is the next best alternative given up. Suppose a cinema ticket costs $12. The price is $12. If the next best use of that $12 was a meal with friends, then the meal is the opportunity cost. If someone gives you a free festival ticket, the price is $0, but there is still an opportunity cost: the time you spend there, which you could have used another way.
1. Listing all the alternatives. Opportunity cost is only the single next best alternative. Do not add up everything you gave up.
2. Saying the opportunity cost is the price. The price is the money paid. The opportunity cost is the best alternative you gave up with that money or time.
3. Saying free means no opportunity cost. Using your time or resources always means something else is given up.
The country of Zelmar has $200 million to spend. The government can build a new hospital, a motorway or a school programme. Citizens rank the hospital as most needed, then the school programme, then the motorway. The government builds the hospital and asks its builders to work extra hours at weekends for higher pay.
(a) Define opportunity cost. [2 marks]
(b) Identify the opportunity cost to Zelmar of building the hospital. [1 mark]
(c) Explain why a builder might refuse the extra weekend hours even though they are paid more. [3 marks]
(a) Opportunity cost is the next best alternative (1) given up when a choice is made (1).
(b) The school programme (1).
(c) The builder has limited time (1). Working extra hours means giving up something else, such as rest or time with family (1). If the builder values that free time more than the extra pay, the opportunity cost is too high, so they refuse (1).
In part (b), name only ONE alternative: the second choice in the ranking, not the motorway as well.