Hi Everyone,

Opportunity cost is the cost of any activity measured in terms of the value of the next best alternative forgone.

Opportunity cost is one of the most important concepts in economics. Opportunity costs consider what we forgo in order to obtain something else. Normally when we consider costs, we consider the monetary cost of acquiring something. For example, a cup of coffee might cost you $4 (price). Opportunity cost goes a step further by considering what you would have done with the $4 if you had not bought the coffee. The opportunity cost of a $4 coffee might be a $4 tea. It might be a $2 coffee and a $2 doughnut.

Everything has an opportunity cost. Even the things or activities that have no monetary cost. For example, walking along a beach does not incur a monetary cost. However, the time spent walking along the beach could have been used for doing something else. The opportunity cost of walking along the beach could be the lost opportunity of walking by the lake or in the forest.

Application of opportunity costs to education

What are the costs of higher education? From a direct financial perspective, we would include the costs of tuition fees, books, stationary, transport, lodging, and even food. For example, this could add up to $20,000 a year. What this does not include is what you could have done with your time if you were not attending lectures, preparing assignments, and studying. You could have been working and earning a salary. The salary that you would have earned (e.g. $30,000 a year) should be considered as an opportunity cost of higher education. The interest that could have been earned from the salary could also be included as an additional opportunity cost. Whereas some of the costs such as transport, food and lodging should not be fully included as part of the opportunity costs as they would have been incurred to some extent if you had chosen a job.

Acquiring a higher education, in most cases, provides opportunities to earn a higher salary upon graduation. This higher salary can be considered a future opportunity cost of choosing to work instead of obtaining a higher education. There is also the opportunity cost of the enjoyment of university life that would be forgone by working. However, some people also obtain enjoyment from their jobs as well. The opportunity cost should be the net difference in enjoyment.

In my 2007 master’s thesis ‘Is the Pursuit of Higher Education Worth the Cost?’. I investigate the return to higher education in terms of utility. The loss of income from studying creates a loss of opportunity for enjoyment (utility) in the short-run. However, higher income obtained from a higher education creates more opportunities for potential utility in the future. Does the loss of utility from no income in the short-run outweigh the gain in potential utility in the future from a higher income? The thesis considered different groups of people with different characteristics to determine if obtaining higher education was favourable to entering the workforce sooner.

For more information about utility you can read my post 'Economic Concepts #1 - Utility'.

Further application of opportunity cost

I have discussed in my post, ‘Quality of Life as Quality of Time’, the importance of enjoying as much of your time as possible. The theory of opportunity cost strongly supports the assertions made in this post. For example, spending long hours at a job to earn a high income. Do the benefits of the high income outweigh the opportunity costs of working long hours? Does the higher income enable you to add more value to the shorter time not spent working? Does the amount of enjoyment you obtain from your work affect the number of hours you work and the opportunity cost of this work?

Conclusion

Everything we do involves some form of opportunity cost. Committing time and resources to a particular activity means that another activity will be forgone. Therefore, understanding opportunity cost can help us make better use of our time and resources.

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