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Examples of Opportunity cost

Opportunity cost

Post by natttt
Posted on 2011-01-11 10:29:08
Opportunity cost is the cost related to the next-best choice available to someone who has picked among several mutually exclusive choices. It is a key concept in economics. It has been described as expressing "the basic relationship between scarcity and choice." The notion of opportunity cost plays a crucial part in ensuring that scarce resources are used efficiently. Thus, opportunity costs are not restricted to monetary or financial costs: the real cost of output forgone, lost time, pleasure or any other benefit that provides utility should also be considered opportunity costs.

Examples of opportunity cost:

Example #1: Jocelyn has $13 and has the option of either buying a music CD or a pair of shorts. If she goes for the pair of shorts, she does so by giving up on the opportunity of buying the CD and, hence, in this case her opportunity cost would be the CD. However, if she opts for the CD, she does so by giving up on the opportunity of buying the shorts and, hence, here her opportunity cost is the pair of shorts. In this example, the choice is not among several but only between two mutually exclusive items. However, in case of more than two mutually exclusive items also, the opportunity cost is the value of just one item and not the rest of them as only one alternative - the next best - is considered for calculating opportunity cost.

Example #2: Josh holds stocks worth $10,000. He has the option of either selling them for $15, 000 at present or to wait for 3 months by which time the prices are expected to go further up. Being the cautious person he is, Josh decides to sell them for $15, 000 today as he is of the opinion that if, instead of rising the stock prices fall then he might incur a loss. By giving up on the opportunity to sell his $10, 000 worth stocks in future for a price higher than $15, 000, he is incurring an opportunity cost, the value of which would be decided 3 months later. Therefore, his opportunity cost is the future price of his stocks which may be more or less than $15, 000 or even lesser than $10,000. From this opportunity cost example, we can see that the next best alternative need not belong to the same time frame as the selected alternative.

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