Opportunity Cost
Value of the next best alternative foregone.
Formula
Variables
Example
The true cost of a choice
How it works
Opportunity cost measures what you sacrifice when you choose one option over the next best alternative. The formula compares the value of the option you give up to the value of the option you gain, so it helps you judge whether a decision is worth it. It works because every choice uses limited resources like time, money, or labour, and those resources cannot be used twice at the same time.
When to use it
Use this when comparing two or more alternatives and you need to know the cost of choosing one over another. It is common in economics, business decisions, personal budgeting, and any situation where resources are limited.
Worked example, step by step
A student can either work a 4-hour shift for $60 or study for an extra 4 hours that could improve their test score. Step 1: Identify what is given up = $60 from the job. Step 2: Identify what is gained = the value of the better test result, which in this example is treated as $40 of benefit. Step 3: Apply the formula: OC = what you give up / what you gain Step 4: OC = 60 / 40 Step 5: OC = 1.5 Final answer: The opportunity cost ratio is 1.5, meaning the student gives up $1.50 of income for every $1 of study benefit in this comparison.
Common mistakes to avoid
- Treating opportunity cost as only the money spent, not the value of the next best alternative
- Forgetting to compare the best alternative, not every possible alternative
- Mixing up the values of what is given up and what is gained in the formula
Did You Know?
Comparative advantage shows why nations gain by trading even when one makes everything more efficiently.
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