What this lesson teaches
I can explain the trade-off and the opportunity cost (the next best thing given up) in a choice.
Syllabus 9570, 1.1.1(c). Scarcity, choice and resource allocation: When choices are made, trade-offs and opportunity costs are incurred
I can explain scarcity, choice and opportunity cost from the view of a consumer, a producer and a government.
Syllabus 9570, 1.1.1(d). Scarcity, choice and resource allocation: The concepts of scarcity, choice and opportunity cost can be explained from the perspectives of different economic agents (consumers, producers and governments)
Make a guess
You skip a free concert to work a $60 shift. Your other option was helping a friend move house. What did the shift cost you?
- The concert or the move, whichever you valued more.
- No cost, because you earned $60 rather than spending it.
- The $60, because that is what the shift is worth.
- The concert and the move added together.
Show the answer
The concert or the move, whichever you valued more.
Opportunity cost is the single next-best alternative you gave up. You could only have done one of the other two instead.
Opportunity cost is the next-best alternative given up when you make a choice.
Every choice has a cost: the next-best alternative you gave up. This is the opportunity cost.
It is only the next-best alternative, not all the alternatives added together. If you choose one option, you could only have had one other in its place.
Opportunity cost is not just money. Studying tonight costs you the time you could have spent resting or working a part-time shift.
Governments face opportunity costs too. Money spent on defence cannot be spent on healthcare for an ageing population.
- Opportunity cost
- The next-best alternative given up.
- Only one
- Do not add up all the rejected options.
Worked example: Three uses for a workshop
A firm has one free workshop slot. Repairing equipment is worth $120 to it, renting out the space $90, and making shelves $70.
- The best choice is repairing equipment ($120).
- The next-best alternative is renting the space ($90).
- So the opportunity cost of repairing is $90, the rental income given up.
- It is not $90 + $70 = $160: the firm could only have done one of those instead.
Watch out for this
The opportunity cost is the value of all the options you did not choose.
You could only have picked one of them, so the opportunity cost is the value of the next-best one.
Check your understanding
Mei chooses to go to university. Her next-best option was a job paying $2,500 a month. Her third option was travelling. What is her opportunity cost?
- The job and the travel together, since she gave up both options.
- The $2,500 a month she could have earned.
- Her tuition fees, since that is the money she actually pays.
Show the answer
The $2,500 a month she could have earned.
Right. That is her next-best alternative.