Opportunity cost
is the value of what is foregone in order to have something else. This value is
unique for each individual. You may, for instance, forgo ice cream in order to
have an extra helping of mashed potatoes. For you, the mashed potatoes have a
greater value than dessert. But you can always change your mind in the future
because there may be some instances when the mashed potatoes are just not as
attractive as the ice cream. The opportunity cost of an individual's decisions,
therefore, is determined by his or her needs, wants, time and resources
(income).
This is important to the PPF because a country will decide how to best allocate
its resources according to its opportunity cost. Therefore, the previous
wine/cotton example shows that if the country chooses to produce more wine than
cotton, the opportunity cost is equivalent to the cost of giving up the
required cotton production.
Let's look at another example to demonstrate how opportunity cost ensures that
an individual will buy the least expensive of two similar goods when given the
choice. For example, assume that an individual has a choice between two
telephone services. If he or she were to buy the most expensive service, that
individual may have to reduce the number of times he or she goes to the movies
each month. Giving up these opportunities to go to the movies may be a cost
that is too high for this person, leading him or her to choose the less
expensive service.
Remember that opportunity cost is different for each individual and nation.
Thus, what is valued more than something else will vary among people and
countries when decisions are made about how to allocate resources.
Opportunity cost refers to the
value forgone in order to make one particular investment instead of another.For
example, let's assume you have $15,000 that you could either invest in Company
XYZ stock or put toward a graduate degree. You choose
the stock. The opportunity cost in this situation is the increased lifetime earnings that may have resulted from
getting the graduate degree -- that is, you choose to forgo the increase in
earnings when you use the money to buy stock instead.
Here's another example. Let's say you have
$15,000 and your choice is to either buy shares of Company XYZ or leave the money
in a CD that earns only 5% per year. If the Company XYZ stock returns
10%, you've benefited from your decision because the alternative would have
been less profitable. However, if Company XYZ returns 2% when you could have
had 5% from the CD, then your opportunity cost is (5% - 2% = 3%).
Opportunity
cost is all about the most basic of economic concepts: trade-offs. It's a
notion inherent in almost every decision of daily life and of investing: if you
make a choice, you forgo the other options for now. And what's been given up
can sometimes turn out to have been the wiser choice, which is why opportunity
cost is best measured in hindsight -- after all, it is impossible to know the
end outcome of any investment. Opportunity
costs are a factor not only in consumer decisions,
but in production decisions, capital allocation, time management, and
lifestyle choices.