Choice and opportunity cost
When you make a choice to buy something you exchange cash for a product or service. For most people, cash is relatively scarce. So this choice means that spending the cash on means that it cannot be used to buy something else. This introduces the concept of opportunity cost.
The opportunity cost of an activity is the sacrifice made to do it. It is the real cost of the next best alternative foregone when an economic decision is made. The more a nation produces of one thing, the less of something else it can produce. The sacrifice of the alternative is the opportunity cost.
A few examples:
- The government choose to spend more on health care. This may mean sacrifices elsewhere and may mean less spent on affordable housing. The reduction in housing is the opportunity cost.
- The opportunity cost of working overtime (supplying more labour) is the leisure time that you have sacrificed.
- You own a lawnmower that you rarely use. It has a second hand value of $50. The opportunity cost of keeping the mower is $50.
- You are given $400 as an 18th birthday present. You decide to spend it on a holiday rather than put it into a long - term saving account. The opportunity cost of the holiday is the savings that have been given up.
- You buy a CD instead of purchasing lunches for a week. The opportunity cost of the CD is the lunches given up.
The fact that there is an opportunity cost to every transaction means that we all face trade-offs in the decisions we make. As a society, we cannot have everything we want and so to have more of one thing, we may have to have less of another. This notion of trade-offs is one that will recur throughout your economics course. It will also arise when we look at the management of the national economy as governments face trade-offs as well as individuals. They may want low unemployment and low inflation, but less of one may mean more of the other.
Remember, however, that opportunity cost is not a financial cost - it is a resource cost, i.e. what's given up in real, as opposed to money terms.