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What Is Opportunity Cost?
The opportunity cost (also called an implicit cost) of a decision is the value of what you will lose or miss out on when choosing one possibility over another. While tangible factors like money are the most obvious opportunity costs, there are also a variety of intangible trade-offs, like time with your friends and family.
5 Examples of Opportunity Cost in Business Decisions and Everyday Situations
Opportunity cost applies in a variety of situations, from everyday choices to business decisions. Consider the following examples of opportunity cost:
- A young woman wants to spend her time either working as a financial advisor or volunteering for a non-profit. She decides to volunteer. The opportunity cost of her choice is the money she would have made working.
- A high-school student receives $50 as a birthday gift. They decide to buy themselves a new pair of shoes with the money. The opportunity cost in this situation is the ability to buy something else with the $50—they chose to buy shoes, and they are now missing out on the ability to buy something else.
- A manufacturer gets two orders and can only fulfill one. The first order has a profit of $50 and the second has a profit of $75. The manufacturer chooses to fulfill the second order to maximize the profit and declines the first order. In this situation, the opportunity cost of the decision is $50, because the manufacturer foregoes a $50 profit (in favor of a $75 profit).
- A couple wants either to invest their money in the stock market or deposit it into a bank to collect interest. They choose to invest in the stock market. The opportunity cost of investing in the stock market is the assurance that their money will increase; they choose to forgo that security in favor of a possible higher return on investment.
- A teenager gets three summer-job offers: a full-time job that pays $15 an hour, a full-time job that pays $10 an hour, and a night-shift job that pays $20 an hour. The teen knows that if they choose a full-time job, they’ll be able to hang out with their friends in the evenings, but if they choose the night-shift job, they won’t. The teen chooses the night-shift job—that means the value of the next best alternative is $15 an hour, plus the ability to hang out with friends in the evening. Those are the opportunities they will now miss out on because they chose the $20-an-hour night-shift job.
How Do You Calculate Opportunity Cost in Business?
Opportunity costs are a major factor in business and production. Businesses calculate opportunity costs when determining the value of particular financial decisions they can make with their limited resources.
To estimate the value of a decision, businesses use the following variables:
- Total revenue. This is the total amount of money a business makes over a specified period of time.
- Explicit costs. Explicit costs are the costs of a decision that require a payment, like the cost of capital. If a person decides to go to college instead of staying home, the explicit costs of their decision are tuition, room and board, and books. If a business must pay $1,000 per month in rent and $200 in utilities to stay open, their explicit total cost of staying open is $1,200.
With these variables, a business can calculate opportunity costs with the following formula:
Value of decision = Total revenue – Explicit costs
How Do You Calculate Opportunity Cost in Everyday Life?
For most everyday decisions, however, opportunity cost doesn’t need a mathematical formula, because it’s already in a plain number form: for example, when you miss out on a $50 profit in favor of a $75 profit, your opportunity cost is simply $50.
In other everyday decisions, the opportunity cost is unquantifiable. For example, it’s difficult to quantify the value of a low-paying fulfilling job versus a high-paying unfulfilling one.
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