Opportunity Costs Definition AP Macroeconomics Key Term

For example, if you decide to spend time studying for an exam instead of going out with friends, the opportunity cost is the enjoyment and social interaction you forego during that time. If the opportunity cost were described as “a nice vacation” instead of “$5 a day,” you might make different choices. The idea behind opportunity cost is that the cost of one item is the lost opportunity to do or consume something else; in short, opportunity cost is the value of the next best alternative. A fundamental principle of economics is that every choice has an opportunity cost. A process by which decisions are made based on weighing the costs of an action against its benefits.

Decision-making often involves cost-benefit analysis, where the benefits of a decision are weighed against the opportunity costs to determine the most beneficial course of action. The same process of selecting between payment and action may be employed to monetize opportunity costs in other contexts. Add the value of the next best alternatives (the opportunities that would have been chosen had the choice not been available) and you have the total opportunity cost. Economic profit is the difference between a firm’s total revenue and its total economic costs, which include both explicit and implicit costs. Recognizing opportunity costs helps in evaluating the true cost of decisions, guiding rational decision-making processes. Clearly, the opportunity costs of waiting time can be just as substantial as costs involving direct spending.

• If the total benefit of going to the movies is larger than the total cost (implicit and explicit), a rational person would go to the movies.
• In principle there exists a critical price at which you’re indifferent to “doing the time” or “paying the fine.” That price is the monetized or dollar cost of the jail sentence.
• This differential, known as a risk premium, is the monetization of the risk portion of a gamble.
• Imagine, for example, that you spend $8 on lunch every day at work.
• You could eat a hamburger, salad, sandwich, or burrito (these are all of your alternatives).

Fundamental Concepts

Economists commonly place a value on time to convert an opportunity cost in time into a monetary figure. It’s the https://mhotel.in/9-best-real-estate-accounting-software-of-2025/ opportunity cost of additional waiting time at the airport. Universal health care would be nice, but the opportunity cost of such a decision would be less housing, environmental protection, or national defense.

Opportunity Cost and Individual Decisions

That means people tend to act in their own best interest. You could eat a hamburger, salad, sandwich, or burrito (these are all of your alternatives). For example, if you choose to go to soccer practice, you lose the opportunity to hang out with your friends.

As a result, people only make a particular choice when the benefits outweigh the costs. If someone chooses to spend money (explicit cost), that money could be used to purchase other goods and services so the spent money is part of the opportunity cost as well. If someone loses the opportunity to earn money (implicit cost), that is part of the opportunity cost. There are two types of cost that total the opportunity cost for a choice. A technique used to assess the additional benefits of an action compared to its additional costs, often used to determine optimal decision-making.

What is the opportunity cost of 30 days in jail? Owning a puppy is a good illustration of opportunity cost, because the purchase price is typically a negligible portion of the total cost of ownership. The opportunity cost of a puppy includes not just the purchase price but the food, veterinary bills, carpet cleaning, and time value of training as well. The opportunity cost is the value of the best forgone alternative. If the total benefit of going to the movies is larger than the total cost (implicit and explicit), a rational person would go to the movies. So when you hear cost, it is the implicit and explicit costs added together.

Which of the following best describes the relationship between trade-offs and opportunity costs?

If you sleep through your economics class (not recommended, by the way), the opportunity cost is the learning you miss. Since resources are limited, every time you make a choice about how to use them, you are also choosing to forego other options. It emphasizes the trade-offs involved in every decision, illustrating that when resources are allocated to one option, the benefits of the other options are lost. That is, they reveal their preference for owning the puppy, as the benefit they derive must apparently exceed the opportunity cost of acquiring it. Yet people acquire puppies all the time, in spite of their high cost of ownership. For example, the cost of a university education includes the tuition and textbook purchases, as well as the wages that were lost during the time the student was in school.

Because many air travelers are relatively highly paid businesspeople, conservative estimates set the average “price of time” for air travelers at $20 per hour. However, the single biggest cost of greater airline security doesn’t involve money. Opportunity cost also comes into play with societal decisions.

This review page covers this basic economic concept of opportunity cost. The alternatives that must be given up when one option is chosen over another, highlighting the choices faced when resources are limited. The fundamental economic problem of having seemingly unlimited human wants in a world of limited resources, necessitating choices and trade-offs. Opportunity costs refer to the value of the next best alternative that is forgone when a decision is made to choose one option over another. Opportunity cost is best described as b) benefits foregone by not choosing an alternative course of action.

Review Questions

• A basic assumption in Microeconomics is that people are generally rational.
• Universal health care would be nice, but the opportunity cost of such a decision would be less housing, environmental protection, or national defense.
• If someone chooses to spend money (explicit cost), that money could be used to purchase other goods and services so the spent money is part of the opportunity cost as well.
• Opportunity cost refers to the value of the next best alternative that is forgone when a choice is made.
• The economic view of the world is that people acquire puppies because the value they expect exceeds their opportunity cost.
• Decision-making often involves cost-benefit analysis, where the benefits of a decision are weighed against the opportunity costs to determine the most beneficial course of action.
• Opportunity cost is best described as b) benefits foregone by not choosing an alternative course of action.

Monetizing opportunity costs is valuable, because it provides a means of comparison. Even though opportunity costs include nonmonetary costs, we will often monetize opportunity costs, by translating these costs into dollar terms for comparison purposes. The economic view of the world is that people acquire puppies because the value they expect exceeds their opportunity cost. However, some “costs” an opportunity cost is best described as apex are not opportunity costs. When answering questions about opportunity costs on a PPC graph, just look to the axes. Other decisions cannot be broken down incrementally and must be made while looking at total benefits and total costs.

More Related Questions

Opportunity cost is the value of the best alternative not chosen. Evaluate eachopportunity by what would be gained if you chose an alternativeopportunity. Evaluatecost by hour, day, week, or year for each option. Explicit costs are the actual monetary payments made by a firm for inputs such as wages, rent, and raw materials. It represents the tradeoffs involved in deciding how to allocate scarce resources between competing alternatives. This economic concept reflects the potential gains you miss out on when you make a choice.

This concept is closely linked to efficiency and scarcity, as it emphasizes the importance of maximizing benefits while minimizing costs in resource allocation. Opportunity cost refers to the value of the next best alternative that is forgone when a choice is made. The act of giving up one thing in exchange for another, reflecting the choices individuals or businesses face when allocating limited resources. Whenever you decide on one option over another, the opportunity cost is what you give up in order to pursue that chosen option. Accordingly, the opportunity cost of delays in airports could be as much as 800 million (passengers) × 0.5 hours × $20/hour—or, $8 billion per year.

However, if you project what that adds up to in a year—250 workdays a year × $5 per day equals $1,250—it’s the cost, perhaps, of a decent vacation. If you are indifferent to buying the airbag, you have implicitly valued the probability of death at $400 per 0.01%, or $40,000 per 1%, or around $4,000,000 per life. Suppose a $400 airbag reduces the overall risk of death by 0.01%. Wearing seatbelts and buying optional safety equipment reduce the risk of death by a small but measurable amount.

Room and board are a cost of an education only insofar as they are expenses that are only incurred in the process of being a student. Room and board would not be a cost since one must eat and live whether one is working or at school. For an economist, the cost of buying or doing something is the value that one forgoes in purchasing the product or undertaking the activity of the thing. Economists think of cost in a slightly quirky way that makes sense, however, once you think about it for a while. The production possibilities curve illustrates different combinations of two goods (or groups of goods) that can be produced with fixed resources. Later you will learn most decisions are made incrementally at the margin.

If you choose to marry one person, you give up the opportunity to marry anyone else.