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In economics, 'opportunity cost', or 'economic cost', is ''the cost of something in terms of an opportunity forgone'' (and the benefits which could be received from that opportunity), or ''the most valuable forgone alternative'' (or highest-valued option forgone), i.e. the second best alternative. An early representation of the concept of opportunity cost is the broken window fallacy illustrated by Frédéric Bastiat in 1850.
For example, if a city decides to build a hospital on vacant land it owns, the opportunity cost is the cost of ''some other thing'' which might have been done with the land and construction funds instead. In building the hospital, the city has forgone the opportunity to build a sporting center on that land, or a parking lot, or the ability to sell the land to reduce the city's debt, since those uses tend to be mutually exclusive. Also included in the opportunity cost would be what investments or purchases the private sector would have voluntarily made if it were not taxed to build the hospital. The total opportunity costs of such an action can never be known with certainty (and are sometimes called "hidden costs" or "hidden losses", because what has been prevented from being produced cannot be seen or known). Even the possibility of inaction is a lost opportunity (in this example, to preserve the scenery as-is for neighboring areas, perhaps including areas that it itself owns).
Opportunity cost need not be assessed in monetary terms, but rather can be assessed in terms of ''anything'' which is of value to the person or persons doing the assessing (or those affected by the outcome). For example, a person who chooses to watch, or to record, a television program cannot watch (or record) any other at the same time. (The rule still applies if the recording device can simultaneously record multiple programs; there is going to be a limit, and if the number of desired programs exceeds the capacity of the recorder, some of them will not be saved, and thus cannot be seen.) In any case, at the time the person chooses to watch a program, either live or on a recording, they cannot watch something else, and if they are not able to record another program showing at the same time, the opportunity to view it is lost (presuming the particular program is not repeated). Or as another example, someone having a video game can choose to watch a program or play the video game on the TV; they can't do both simultaneously. Whichever one they choose is a lost opportunity to experience the other. Or for that matter, a lost opportunity to engage in some other activity entirely (exercising outdoors, or visiting with family or friends, as merely two examples).
The consideration of opportunity costs is one of the key differences between the concepts of ''economic cost'' and ''accounting cost''. Assessing opportunity costs is fundamental to assessing the ''true cost'' of any course of action. In the case where there is no explicit accounting or monetary cost (price) attached to a course of action, ignoring opportunity costs may produce the illusion that its benefits cost nothing at all. The unseen opportunity costs then become the implicit ''hidden costs'' of that course of action.
Note that opportunity cost is not the ''sum'' of the available alternatives, but rather of benefit of the best alternative of them. The opportunity cost of the city's decision to build the hospital on its vacant land is the loss of the land for a sporting center, ''or'' the inability to use the land for a parking lot, ''or'' the money which could have been made from selling the land, ''or'' the loss of any of the various other possible uses -- but not all of these in aggregate, because the land cannot be used for more than one of these purposes.
However, most opportunities are difficult to compare. Opportunity cost has been seen as the foundation of the marginal theory of value as well as the theory of time and money.
In some cases it may be possible to have more of everything by making different choices; for instance, when an economy is within its production possibility frontier. In microeconomic models this is unusual, because individuals are assumed to maximise utility, but it is a feature of Keynesian macroeconomics. In these circumstances opportunity cost is a less useful concept.

Contents

Pitfalls in the calculation of Opportunity Costs: Hidden Costs

See also

External links

Pitfalls in the calculation of Opportunity Costs: Hidden Costs

One has to be careful in calculating the opportunity cost of any course of action. There are two pitfalls in the way of such a calculation: some relevant costs may be ignored in the calculation and some costs which should not be included may be included. For example: Sunk costs should not be included in opportunity costs because once that cost is incurred, sunk costs are not part of the firm's alternatives because they cannot be put to alternative use.
In a brief summary, an opportunity cost is the benefit lost from making one choice over another. Further, not ''all'' foregone opportunities are counted in the calculation, but only the costliest of those foregone.
When government taxes to provide what are seen as social goods, there is no way to know with certainty what the opportunity cost of this action is. If this money were left in the private sector, it would have been directed toward different investments and projects. These opportunity costs are "hidden" because one cannot see what has not been produced due to the taxation. Especially complicating the matter is that what investments and spending would have been voluntarily made varies from individual to individual according to each one's particular goals. As a result, one cannot know whether the opportunity costs of taxing to provide a social good is greater or less than the social benefit provided. For this reason, some argue that whenever possible it is best to simply leave the wealth in the private sector and allow voluntary decision of what projects to pursue through the operation of markets. Others do not trust markets to provide social goods and prefer government to force investment.

See also

★ Cost overrun

★ Efficiency

★ Inefficiency

★ Market failure

★ Neoclassical Revolution

★ Parable of the broken window

★ Production possibility frontier

★ Trade-off

★ TANSTAAFL

★ Unintended consequence

★ User Cost of Capital

★ Tacit collusion

External links

★ Opportunity Cost in the ''Concise Encyclopedia of Economics'' at Econlib

★ Baseball Players and Opportunity Costs (About.com)