opportunity cost

Although the concept of opportunity cost is fundamental, incorrect conclusions can result from difficulties in applying the concept. More restricted perspectives may mask the fact that costs are simply being shifted to another sector rather than being saved.

“Opportunity costs means “What else could I have done with my money? ” says Adem Selita, chief executive officer at The Debt Relief Company in New York, N.Y. In the meantime, start building your store with a free 3-day trial of Shopify. Opportunity cost is an economics term that refers to the value of what you have to give up in order to choose something else. This blog explains everyday economics, consumer topics and the Fed. It also spotlights the people and programs that make the St. Louis Fed central to America’s economy.

Opportunity Cost and Risk

The purpose of calculating economic profits is to aid in better business decision-making through the inclusion of opportunity costs. In this way, a business can evaluate whether its decision and the allocation of its resources is cost-effective or not and whether resources should be reallocated.

Opportunity cost is useful when evaluating the cost and benefit of choices. For example, if one has time for only one elective course, taking a course in microeconomics might have the opportunity cost of a course in management. By expressing the cost of one option in terms of the foregone benefits of another, the marginal costs and marginal benefits of the options can be compared.

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The money earned in the market represents the opportunity cost of the asset utilized in the business venture. As a result, opportunity costs must be incorporated into project planning to avoid erroneous project evaluations.

opportunity cost

Accordingly, the opportunity cost of delays in airports could be as much as 800 million × 0.5 hours × $20/hour—or, $8 billion per year. Clearly, the opportunity costs of waiting time can be just as substantial as costs involving direct spending. Another example of opportunity cost is something as simple as choosing between going to work and skipping work. Opportunity cost doesn’t always need to apply to investments or money; it can also apply to life decisions.

Real-Life Examples of Opportunity Cost

For this reason, it’s a best practice in the investment profession to match an individual’s investment portfolio to their risk tolerance and time horizon. This concept acknowledges not just the explicit costs of a choice but also the implicit costs of what you forgo when you make that decision. Opportunity cost provides a framework for decision-making to find the most benefit, particularly for limited resources like time and money. Implicit costs are opportunity costs when you use an asset instead of selling or renting the asset to someone else. Economic profit takes implicit costs into account as an extra opportunity cost when you subtract both explicit and implicit costs from total revenues. Accounting profit only takes explicit costs into account when subtracting explicit costs from total revenues. When it comes to investment returns, you’ll just need to sub in the expected rates of return of each option.

We can use this to illustrate how https://www.bookstime.com/ calculations are made. Opportunity costs are a major concept in economics and the key distinction between economic costs and accounting costs. Accounting costs are the monetary costs recorded on the books, whereas economic costs include accounting costs plus opportunity costs. Indirect or non-monetary costs that are taken into consideration for calculating economic costs but not for calculating accounting costs include most notably time costs. In health care research, there exist opportunity costs of health as well, discussed more later in the context of cost effectiveness analyses.

Opportunity Cost Example: Simple Investments

Her work has appeared on The Penny Hoarder, NerdWallet, and more. Return on revenue is a measure of a corporation’s profitability that compares net income to revenue. Full BioAmy is an ACA and the CEO and founder of OnPoint Learning, a financial training company delivering training to financial professionals. She has nearly two decades of experience in the financial industry and as a financial instructor for industry professionals and individuals.

  • Opportunity cost is an economics term that refers to the value of what you have to give up in order to choose something else.
  • That’s because each time you choose one option over another, you’ve lost out on something.
  • The opportunity cost is having the electricity turned off, having to pay an activation fee and late charges.
  • It takes 70 minutes on the train, while driving takes 40 minutes.
  • And sometimes it is low, or negative relative to what you will now spend, such as if your next-best option was retail space on the next block that was renting for $15,000/month.
  • In general, the greater the risk that you lose money on an investment, the higher returns it provides.
  • Return on revenue is a measure of a corporation’s profitability that compares net income to revenue.