The Concept of Opportunity Cost

Wayne Gretzky, a Canadian hockey player, once said, “You miss 100% of the shots you don’t take.” Have you ever wondered why this phrase applies to almost all the situations you’ve ever been in? Or why people around us always tell us to take every chance we get? It’s because it all sums up to the concept of opportunity cost.

Opportunity cost is the next best alternative forgone—a concept derived from economics, but its beauty is that it applies to all contexts. Imagine you accidentally make plans that clash. You’re supposed to attend a dinner party at Friend A’s house, but also go to Friend B’s art exhibition. After an hour of contemplation, you finally come to the conclusion that you’ll attend the dinner party. For you, the opportunity cost is the time you could’ve spent with Friend B at their gallery. Similarly, we face tough decisions every day, and each choice we make is influenced by its opportunity cost. Because of scarcity, we all face the dismal reality that there are limits to what we can do. No matter how productive we become, we can never accomplish and enjoy as much as we would like. In fact, the only thing we can do without limit is desire more.

Scarcity is caused by unlimited wants and limited resources. To help make the most optimal decision, firms use opportunity cost (OC) to their advantage. Firstly, they use OC to make investment decisions. To invest in physical capital, intangible assets (like branding), or even human capital, evaluating the costs helps them decide which investment would be fruitful in the current state. By marginal analysis—a decision-making tool used to examine the benefits and costs of a small change in activity or resource use—a firm decides how to operate at its maximum efficiency. Furthermore, OC is used in the allocation of labour. It helps decide whether to pick up new, unskilled labour and train them, or to give skilled and experienced labour a quick crash course before putting them to work.

In the early 2000s, Google, one of the world’s most innovative tech companies, famously introduced a “20% Time” policy. In this policy, workers are allowed to spend 20% of their time per week working on side projects that aren’t related to their role. This highlights that Google is willing to sacrifice 20% of productive hours to ensure employees work to their best potential in the remaining 80% of work hours. Additionally, governments use OC for policy-making. Evidently, they use it to choose where to spend their money on education, health, or defence. However, it is also used for larger, in-depth, and crucial decisions. For example, India’s 2023 Union Budget prioritised infrastructure spending but drew criticism for underfunding job schemes like MGNREGA.

Someone who decides to begin work straight away rather than getting their master’s applications approved are yet another OC example. For that person, the best choice is working and earning, but the next best alternative would’ve been spending the same time and effort to achieve their master’s degree. Each year, countless students have to face the opportunity cost involved in choosing the most suitable course, timetable, or career path. Additionally, when we decide to go out rather than study, or to listen to music instead of doing dance practice, it’s all affected by OC. At the end of the day, time is scarce, and we choose how we spend our day based on what matters to us the most.

Have you ever stopped to consider what you’re giving up when you make a simple purchase? As much as we don’t realise it, OC applies to our household spending and savings too. When we decide to rent an apartment because we find it more flexible, it’s because our next best alternative—owning an apartment—would simply not meet all our requirements. But tomorrow, if your landlord asks you to either buy the apartment from them or move out, you’d rather buy the apartment than let it go. But why would someone willingly go for the choice that was the next best alternative? In reality, emotions often cloud rational decision-making. The thrill of impulse buying or the pressure of social comparison can cause individuals to ignore the long-term costs of short-term satisfaction.

So, whether you’re a student, painter, CEO, or a stay-at-home parent, opportunity cost crosses your path no matter what activity you do or don’t do. Someone who fully understands this concept has immense power when it comes to making decisions. All in all, understanding opportunity cost doesn’t eliminate trade-offs, but it allows one to make smarter, more informed choices.

References

Rittenberg, Libby. “Opportunity Cost.” Library of Economics and Liberty, Liberty Fund. https://www.econlib.org/library/Topics/College/opportunitycost.html

Strow, Brian. Introduction to Microeconomics. California State University, Northridge. https://www.csun.edu/sites/default/files/micro1.pdf

Palmer, S., and J. Raftery. “Economic Notes: Opportunity Cost.” BMJ, vol. 318, no. 7197, 5 June 1999, pp. 1551–52. PubMed Central (PMC). doi:10.1136/bmj.318.7197.1551

Sources:

1. Rittenberg, Libby. “Opportunity Cost.” Library of Economics and Liberty, Liberty Fund, https://www.econlib.org/library/Topics/College/opportunitycost.html. 

2. Strow, Brian. Introduction to Microeconomics. California State University, Northridge, https://www.csun.edu/sites/default/files/micro1.pdf.

3. Palmer, S., and J. Raftery. “Economic Notes: Opportunity Cost.” BMJ, vol. 318, no. 7197, 5 June 1999, pp. 1551–52. PubMed Central (PMC), doi:10.1136/bmj.318.7197.1551.