# Opportunity cost

In microeconomic theory, the opportunity cost, or alternative cost, of making a particular choice is the value of the most valuable choice out of those that were not taken. In other words, opportunity that will require sacrifices.

When an option is chosen from two mutually exclusive alternatives, the opportunity cost is the "cost" incurred by not enjoying the benefit associated with the alternative choice.[1] The New Oxford American Dictionary defines it as "the loss of potential gain from other alternatives when one alternative is chosen". Opportunity cost is a key concept in economics, and has been described as expressing "the basic relationship between scarcity and choice".[2] The notion of opportunity cost plays a crucial part in attempts to ensure that scarce resources are used efficiently.[3] 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 an opportunity cost.

Opportunity cost of a product or service means the revenue that could be earned by its alternative use. In other words opportunity cost is the cost of the next best alternative of a product or service. The meaning of the concept of opportunity cost can be explained with the help of following examples:

(1) The opportunity cost of the funds tied up in the one's own business is the interest (or profits corrected for differences in risk) that could be earned on those funds in other ventures.

(2) The opportunity cost of the time one puts into his own business is the salary he could earn in other occupations (with a correction for the relative psychic income in the two occupations).

(3) The opportunity cost of using a machine to produce one product is the earnings that would be possible from other products.

(4) The opportunity cost of using a machine that is useless for any other purpose is nil, since its use requires no sacrifice of other opportunities.

Thus opportunity cost requires sacrifices. If there is no sacrifice involved in a decision, there will be no opportunity cost. In this regard the opportunity costs not involving cash flows are not recorded in the books of accounts, but they are important considerations in business decisions.

## History

The term was first used in 1894 by David L. Green in an article in the Quarterly Journal of Economics entitled "Pain Cost and Opportunity-Cost. The idea had been anticipated by previous writers including Benjamin Franklin and Frédéric Bastiat. Franklin coined the phrase "Time is Money", and spelt out the associated opportunity cost reasoning in his “Advice to a Young Tradesman” (1748): “Remember that Time is Money. He that can earn Ten Shillings a Day by his Labour, and goes abroad, or sits idle one half of that Day, tho’ he spends but Sixpence during his Diversion or Idleness, ought not to reckon That the only Expence; he has really spent or rather thrown away Five Shillings besides.”

Bastiat's 1848 essay "What Is Seen and What Is Not Seen" used opportunity cost reasoning in his critique of the broken window fallacy, and of what he saw as spurious arguments for public expenditure.