Opportunity Cost

Definition

Opportunity cost is the value of the next best alternative that must be forgone when making a choice. It represents the trade-offs individuals, businesses, and societies face when allocating scarce resources to different uses.

5 Must Know Facts For Your Next Test

1. Opportunity cost is a key concept in understanding how individuals, businesses, and societies make choices and allocate scarce resources.
2. The opportunity cost of a decision is the value of the next best alternative that is given up when that decision is made.
3. Opportunity cost is a crucial consideration in the study of microeconomics, as it helps explain how individuals and firms make optimal choices.
4. The concept of opportunity cost is also essential in understanding macroeconomic issues, such as how countries make decisions about the allocation of resources for production and trade.
5. Opportunity cost is a fundamental principle in the analysis of economic systems, as it helps explain how different economic systems, such as market economies and command economies, make decisions about the use of resources.

Review Questions

• Explain how the concept of opportunity cost is relevant in the study of 1.1 What Is Economics, and Why Is It Important?
  • Opportunity cost is a central concept in economics because it helps explain how individuals, businesses, and societies make choices about the allocation of scarce resources. The study of economics is fundamentally about understanding how people make decisions in the face of scarcity, and opportunity cost is a key factor in those decisions. By considering the opportunity cost of a choice, economic actors can make more informed and efficient decisions that maximize their well-being or societal welfare.
• Describe how the concept of opportunity cost relates to the distinction between microeconomics and macroeconomics in 1.2 Microeconomics and Macroeconomics.
  • Opportunity cost is a crucial concept in both microeconomics and macroeconomics. At the microeconomic level, individuals and firms must consider the opportunity cost of their choices when allocating scarce resources, such as time and money, to different uses. At the macroeconomic level, governments and policymakers must consider the opportunity cost of their decisions about the allocation of resources for production, consumption, and investment. Understanding opportunity cost is essential for making informed decisions that maximize societal welfare, whether at the individual, firm, or national level.
• Analyze how the concept of opportunity cost is used by economists to understand economic issues, as described in 1.3 How Economists Use Theories and Models to Understand Economic Issues.
  • Economists use the concept of opportunity cost as a fundamental tool for understanding and analyzing economic issues. By considering the opportunity cost of different choices, economists can develop theories and models that predict how individuals, firms, and governments will respond to changes in incentives, prices, and other economic factors. This understanding of opportunity cost allows economists to make more accurate predictions about economic behavior and to evaluate the potential consequences of different policy decisions. The concept of opportunity cost is thus central to the way economists use theories and models to gain insights into the workings of the economy and to inform economic policymaking.

Related terms

Scarcity: The fundamental economic problem where human wants exceed the available resources to satisfy those wants.

Trade-offs: The act of giving up one thing in order to gain another, reflecting the opportunity cost of a decision.

Production Possibilities Frontier (PPF): A graphical representation of the maximum combinations of two goods or services that can be produced given the available resources and technology.