Opportunity Costs and Tradeoffs

An opportunity cost represents what you forego to obtain something that you want. This can be phrased as 'What would you have done had this opportunity not have been available' or 'What was the next best alternative?'

Note: Opportunity costs do not measure all possible alternatives, just the second best one.

Example: Had I not watched the Blue Jay game, I would have studied for my economics test. The opportunity cost of watching the game is the 3 hours of study time lost.

Note that the opportunity cost needs to account for all differences between the choice made and the second best alternative. Suppose I take a one year leave of absence from a job paying $95,000/yr to obtain an MBA at a school with a tuition of $55,000/yr. Then the opportunity cost of the MBA program, measured in dollars, is $150,000. This includes both the $55,000 paid in tuition and the $95,000 lost in wages.

How do we then make the best decisions possible? We need to compare the benefits of anything obtained to the costs of obtaining them. We do this through marginal analysis.

Related Topics: What are Opportunity Costs? and Baseball Players and Opportunity Costs.

Next Lesson: Marginal Analysis.