Table of contents:-
What is Opportunity Cost?
Opportunity Cost is the loss of potential gain of an individual, investor, or business while choosing one alternative over the other.
Analyzing and understanding a missed opportunity lost due to a certain investment over another leads a person to better decision-making.
Opportunity costs can be measured in either time or money. If one is not careful, these opportunity costs can be overlooked fairly easily which may not result in any immediate losses, but can stack up and turn out to be a long term disaster.
Examples of Opportunity Cost
Let us say you get a surprise windfall of $5000. You decide to spend it all on a getaway trip. Sure, why not? Wouldn’t that be great? There is no loss that you incur per se unless you think about Opportunity cost.
So, you do not go on your getaway trip, instead, you invest your money somewhere else which pays you 3% interest compounded yearly.
In 10 years, that investment would grow to $6719. If you want to understand opportunity cost, that $1719 is it.
A baseball player in his high school days decided to train for an extra month instead of taking a vacation and relaxing. The opportunity cost was the vacation.
A college student studies for a test instead of going out and partying with their friends on a weekend. The Opportunity cost was the party and the fun that they gave up.
An opportunity cost might sound to be an intimidating thing due to its name, but it certainly isn’t.
Sometimes a small cost in the form of time or money or entertainment could reap huge dividends in the future.
How do you calculate Opportunity Cost?
Opportunity cost is basically the benefit you forego in pursuing one path over the other.
Though there is no hard and fast mathematical formula to calculate the cost, we generally talk about opportunity cost in terms of investment.
So one can understand it as:
Opportunity cost = ( Return on the most profitable investment – Return on your investment )
The closer this value is to 0, the better is your choice, i.e., the investment you made.
Q: Why is Opportunity cost important?
A: The concept of Opportunity cost enhances our decision-making. It helps us explore every possible option before coming to a final decision. It helps us to use each and every resource available to us carefully and efficiently.
Q: What is the law of Opportunity cost?
A: The law of increasing opportunity cost is an economic principle that describes how each time a resource is allocated, there is an underlying cost of using them for one purpose over another.