One of the key concepts in economics, and indeed in the world as a whole, is that resources are not infinite or freely available. This is indeed the entire basis for economics: if resources were infinite and freely available there would be no need for money. This concept is referred to as the scarcity of resources. As resources are scarce, using a resource to make something means that it cannot be used to make something else. The opportunity to make another good is lost, and therefore the act of producing something is said to have an opportunity cost. In economic terms, then the price of the good is considered, the opportunity cost of making a good is defined as the value of the next best alternative to production, in other words the next best thing which could be made with the available resources.
Opportunity costs are not just a theoretical consideration in economics; they also have real practical impacts on decisions. For example, a manager may decide to return to university to study for an MBA to further their career. The cost of the MBA will be £30,000 over the two years of the course. However, if the manager is currently earning £30,000 per year, and was expecting a £5,000 pay increase in the following year, the two year course will have a cost of £30,000 but an opportunity cost in terms of lost wages of £65,000. Therefore, the total economic cost would be £95,000. If the student can earn an extra £10,000 a year after returning to work, they would need to work for a further nine and a half years to recoup the total economic cost of the MBA. Therefore, they should only choose the MBA if they are confident that they will continue to work in a role which will benefit from the MBA for the next nine and a half years.
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Opportunity costs can also be used to evaluate choices which do not have an obvious monetary impact. For example, if a student is revising for their economics exam, they may have to choose certain revision classes. If microeconomic revision classes last two hours and macroeconomic classes last four hours, then for every macroeconomic class the student goes to will have an opportunity cost of two microeconomic classes. The student needs to weigh up how useful each course is, and where they need the most revision, in order to decide which classes to go to.
Opportunity cost can also be expressed in terms of the price of one good relative to another. For example, if a student on a night out has £20 to spend, beer costs £2 a pint and wine costs £8 a bottle, every bottle of wine the student orders will have an opportunity costs of four pints of beer. In addition, if the student wishes to buy a kebab following the night out, and kebabs cost £4, every pint of beer drunk has an opportunity cost of half a kebab. In cases such as this, the opportunity cost expressed as a relative price can provide more useful information for decision making that the monetary price. As a result of this opportunity cost is often used to assess decisions such as:
- The trade off in consumer choices
- A company’s most efficient production schedule
- The best way to invest capital
- Time management
- Choice of career and education
- The comparative advantage of different producers