We all make choices in our everyday lives. Many choices. But, we rarely think about the opportunity cost.
Do you choose to go to the cinema with friends or spend the money on a new computer game? Perhaps you have enough money to buy the latest CD from your favorite hip-hop star, or you can use the money to buy a Business Studies revision textbook.
Do you choose to buy a new luxury car or go on expensive cruise holidays to the Bahamas with the whole family? As your money is limited, you need to choose only one of those.
Whichever decision you make, it means that you will have to give up the chance of having the other. Either a new car, or the cruise holidays, never both.
The definition of opportunity cost
The next best alternative (desired product or service) which you give up, becomes lost opportunity. It is known as the opportunity cost of your decision. As we decide to purchase or obtain one item, we must give up other goods because they cannot all be purchased at the same time.
Here are a few examples of an opportunity cost:
– If you as a consumer choose to buy a new smartphone instead of a new computer, then the computer becomes the opportunity cost;
– If the charity decides to donate money to help poor children instead of protecting wild animals, protecting wild animals becomes the opportunity cost;
– If the government decides to purchase new military equipment instead of building a new primary school, then the primary school becomes the opportunity cost.
– If an investor decides to buy rental apartments to allocate capital instead of investing on the stock exchange, then stock exchange investment becomes the opportunity cost.
– If you choose to buy shares of Amazon instead of Google because you see bright future in e-commerce, then owning a part of Google becomes your opportunity cost.
How to make choices considering opportunity cost?
To make careful and rational choices, we should choose those things that give is the greatest benefit leaving out those things of less value to us. When making the choice, you need to make sure that the product or service you choose is worth more to you than the one you give up. Smartphone is more valuable than computer. Helping poor children is more important than protecting animals. Winning a war or protecting the country seems more important than educating the youth. Rental apartments will be a better investment than the stock market. And finally, Amazon may bring higher returns in the form of capital gain than Google.
It is not only consumers like you and me who have to make choices about how to use scarce resources. Businesses, managers and governments also have limited resources and must choose between alternative uses of those scarce resources.
For example, a business might have to choose between using capital resources on a new advertising campaign for the latest product, or on a training program for its newly-hired workers. A government might have to choose between building a new school or building a new hospital. But, rarely can do both as we already know that factors of productions are always limited.
Running a business and investing is about making choices. So is daily life.
