Opportunity cost

From economics: The cost of whatever you are doing PLUS the cost of the money you could be making doing something else that paid.

Vacations have a high OC because you are out spending and not putting in overtime. You also have an OC between two jobs, trading money for stress.

Faced with scarcity, we have to make choices. I made a choice to drink the red wine, instead of the white. The developed world made a choice not to forgive third world debt. I'm making a choice in sitting here, writing this node on 1am Christmas day.

Opportunity cost is the cost of what I'm missing out on. It is the value of the BEST alternative forgone. By best alternative in my case, is to be on my bike, cycling my way into the night and out of this joint.

An opportunity cost is expressed in relative prices. If a coffee and a chocolate bar were the only two goods that existed in the world (ok, just pretend), and a coffee cost $1, and a chocolate $0.50, then the opportunity cost of one coffee is two chocolates.

This writeup sounds a bit too bitter to be about economics.

In microeconomic theory, the term "cost" must be understood as "opportunity cost". Whenever a person (or a firm or some other economic agent) undertakes an action she foregoes a number of alternative actions. A day at the races cannot also be a day in June or Ralph (as one's preferences and opportunities may allow). Money spent on a night at the opera cannot also be spent on lingerie. The best foregone alternative to any action a person takes, that is, the action the person would have undertaken if they had not done what they did, is the opportunity cost of that action.

It is difficult to directly measure the opportunity cost of an action taken by a person as one needs to know how much the individual valued a hypothetical action, the next best alternative to the action undertaken. While it is common in microeconomics textbooks to see the claim that the opportunity cost of a consumption good is what could be purchased for the same price, this is only true if the net benefit the consumer gains from consumption (called consumer surplus) of the two alternatives is the same. It is easier to evaluate the opportunity cost of a profit-maximising firm as this is the largest profit the firm forewent when it chose what it did.

For a brief but deep discussion of opportunity cost see James M. Buchanan, 1987, Opportunity cost, in The New Palgrave: A Dictionary of Economics, Ed by John Eatwell et al, Vol. 3, MacMillan ISBN 0-935859-10-1 (set) pp. 718-21. For a history of the concept of cost in economics see James M. Buchanan, 1967-68, Cost and Choice, Liberty Press, available on-line at http://www.econlib.org/library/Buchanan/buchCv6Contents.html.

The problem with many text books concerning any subject is that each text book tends to define something in its own wording. One such definition states that opportunity cost is, "obtaining something (either a service, a product, or time, whatever tangible or intangible thing that can be obtained) by giving up something else." The best way to make any definition concrete is by stating examples, and listed below are some examples.

John Doe is faced with the choice of obtaining a note book from company A or company B, Doe chose company B, the cost of Doe's choice is giving up A to obtain B. Why? Because B is his best alternative, and there are many variables to consider, starting from price, his income, and the features he liked when comparing A over B.

John Doe is considering between working a full time job that pays $20,000, or getting a bachelor degree that will give him $40,000 after graduation. Doe choses education over work, the oppurtunity cost of education is losing the $20,000 job because education is his best alternative. However, he could work, and by working the oppurtunity cost of his working is losing the $40,000 income after graduation.

It all boils down to the best alternative since economics usualy have too many variables to take into consideration.