We live in a world of scarcity,
in the sense that we can never have everything that we might like. As a result we must make choices, for
instance whether to buy this or that, whether to eat this or that, whether to
walk in the park or go to a movie, or whether to produce this or that. Every time we make a choice to do something
we automatically exclude something else that we did not do - we have given it
up. We call this the “opportunity cost”.
Definition - “Opportunity cost is
the best forgone alternative”, i.e. it is what we gave up to get what we did. The
opportunity cost of buying new pair of shoes might be a lunch forgone. The
opportunity cost of buying a new shirt might be not going to the cinema. The
opportunity cost of taking a part-time job might be not being able to hang out
in the mall with your friends.
For a producer
The opportunity cost of buying
plastic packaging material might be the cardboard he did not buy.
NB there can be many alternatives
foregone, but only one will be the opportunity cost - you cannot add them up
and say they are all the opportunity cost, because it must be a choice between
Opportunity cost can be thought
1. The cost in pounds (represents
a real thing given up); or
2. The cost in time.
Opportunity cost is important
1. We use it whenever we are
deciding what to do, for example shall we hire a couple of videos - or buy a
2. It always arises with budget
allocations. At some point in your life
you may have to draw up a budget and allocate money for different
purposes. You will be forced to weigh up
what is really needed in your tennis club, computer society, your country or
3. It lies behind the cost curves
that we draw. How does this work?
Consider two producers,
A and B Producer A might have to
pay £20 a ton to get the iron ore to make into motor cars.
Producer A sees the cost as £20, but we see it as the
way of making sure he gets the resources, rather than letting B get them! So the opportunity cost really does stand
behind the cost curves we draw.
Similarly in consumption: if something costs £10, you have to pay £10
to buy it. That £10 is not only the
price of the object, it is also the amount you have to pay to get the
resources, raw materials, labour etc. that went into making it. This prevented these resources from going
into making something else.
After you buy the item it will be
reordered by the shopkeeper and replaced on the shelf. S/he orders from a wholesaler who in turn
orders more from the producer. The producer then buys the raw materials etc. to
make another of whatever you bought! In
this way, resources keep on going into making whatever people demand.