What is opportunity cost?
Opportunity cost is the potential value lost by not pursuing a particular course of action. It’s the “what could have been” scenario, usually measured in terms of financial benefit. Many businesses use this metric to select the most profitable option when faced with several choices.
While the term originates from the field of economics, opportunity cost has expanded to apply to any situation in which a decision is made. The “cost” can be defined in terms of money, time, output, or any other finite resource.
Examples of opportunity cost
Business: Opportunity cost plays a major role in most business decisions. For instance, if a company wants to expand into a new market - Asia, Europe, or South America - the CEO will probably ask to review the estimated cost of each possible venture - as well as the potential revenue each new region could bring. Let’s say business analysts predict the company could generate $15 million in Asia, $10 million in Europe, and $18 million in South America. Each of those figures represents the opportunity cost of not launching operations in that particular market, with South America holding the highest opportunity cost and Europe the lowest.
Time: Calculating opportunity cost in terms of time can sometimes be more abstract. For example, the decision to spend a Sunday afternoon painting your living room means that time can’t be used for any other purpose. The opportunity cost of those hours becomes all that you weren’t able to do because of your home decor project. That could be grocery shopping, spending time with friends, catching up on emails, and much more. While there’s no official price tag associated with each of these activities, you might decide that what you “miss out on” by not grocery shopping is less critical than what you would give up by not completing the living room.
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Calculating opportunity cost
There are various ways to think about opportunity cost, as it often deals with abstract resources such as time. When it comes to business, the figure is generally not included next to expenses and revenue in quarterly reports. However, it is a monetary value that business owners try to estimate to the best of their ability when making decisions.
For fields outside of business, opportunity cost is more about the choices you make than it is about calculating exact costs with a calculator. The key principle behind opportunity cost is remembering that taking an action or making a decision implies that some kind of finite resource is being forgone.