Understanding opportunity cost
Because resources are scarce, every economic decision involves a trade‑off. Opportunity cost is the value of the next best alternative that is sacrificed when a choice is made. For example, if a government spends money on building a new road, the opportunity cost may be the hospital or school that could have been built with the same funds. Opportunity cost applies to individuals, firms and governments whenever they allocate resources.
Opportunity cost helps explain why choices must be prioritised. It highlights that the true cost of any decision is not simply the money spent but the benefits of the alternative forgone. According to Encyclopaedia Britannica, when you spend money on one good or service you are also choosing not to spend that money on something else: the opportunity cost is “the value of other goods, services, or activities you give up when you choose one investment or activity over another”【768985535492625†L159-L170】.
| Decision | Alternative forgone (opportunity cost) |
|---|---|
| A student chooses to study Economics instead of another subject | The knowledge and qualifications from the alternative subject |
| A firm invests in new machinery | The profits it might have earned by investing the funds elsewhere |
| A government builds a highway | The public housing or hospitals that could have been built with the same funds |
| A person takes a year off work to travel | The wages they would have earned by working during that year |
Thinking about opportunity cost allows economists to evaluate whether the benefits of a decision outweigh the costs. Decisions with lower opportunity costs are generally preferred.
