Opportunity Cost

Definition

“Opportunity Cost” is what needs to be given up to get something. This is different from an item’s price.

mixedlogoImagine you want to buy some stock for your virtual portfolio – you can afford one share of either Apple ( AAPL) or Alphabet, Inc. ( GOOG).

Your Opportunity Cost of buying one is that you cannot also buy the other, meaning you’ll miss out on any potential returns and dividends.

This problem appears in every choice you make – by doing one thing, you can’t do something else. Keeping the opportunity cost of each decision in mind is an important part of both personal finance and economics. Each person needs to keep in mind what they are giving up from each choice (whether it is using their cash to buy one thing or another, or to use it for saving and investing) in order to make sure they are making the most of the resources they have available.

Opportunity Cost For Producers

Producers also face opportunity cost: what will they make?

By putting resources towards building one product, they miss out on potential profits they could have earned by making something else. The same dollar cannot be spent on marketing, research, production, and paying building rental, so all managers need to balance all of the opportunity costs of each decision with the potential benefits.

These opportunity costs also change a lot over time. As a business gets bigger, they have more resources to go around, which means that their opportunity costs (what they need to give up) from each individual action goes down while the potential possibilities goes up.

Opportunity Cost For Consumers

Each time you make a choice between two or more alternatives, you are indirectly saying that the benefit you get is bigger than the opportunity cost. This is not just how you spend your money, it also is how you spend your time.

You could use the same Saturday afternoon to go out with friends, play video games, do research on a new stock you want to buy, practice a new skill, watch TV, find a part-time job, study for school, and everything in between. Whichever option you choose, you have to give the others up, because you can’t be in two places at once.

How do you choose to use your time and resources?

Pop Quiz

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1 of 3) Which of the following would be the Opportunity Cost of buying Apple stock?
2 of 3) Why do opportunity costs change over time?
3 of 3) What is the most finite resource that everyone has?

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