Opportunity Costs

Definition of Opportunity Costs

How can we define opportunity costs? Opportunity costs are costs incurred by a forgone alternative (opportunity). A foregone opportunity can either be the opportunity to incur costs, gain revenues, earn profits, or cause losses. Economic subjects constantly get involved in decision-making processes, where choices must be made, e.g., social interactions between members of society within a certain social order. Take the following examples:

Non-Monetary Opportunity Costs

Example 1: non-monetary opportunity costs – the reason why a student would attend high school (an institution of education) is determined by the opportunity cost incurred if the student would not attend the school e.g. the impression of the parents about their daughter or son. Such opportunity cost are not measurable in monetary units, but can me explained using preferences and utility as quantifiers of level of satisfaction.

Mental Accounting

Examples 2: mental accounting – whenever you act or choose not to act in certain manner, you are weighing alternative options and therefore intrinsically accounting for cost that would be incurred by alternative mode of behavior. Depending on time, location and environmental conditions people make decision about activities, reactions and tactics.

Relative Costs between Alternatives

Example 3: relative costs – a job-seeker may prefer a job that pays less but offers a better work-life balance at the expense of a better-paying job under a worse work-life balance.

Specialization and relative costs or benefit

Example 4: Specialization and relative cost/benefit advantage – the opportunity cost of Germany producing autos are the cost incurred for not producing other goods that Germany prefers to import from other countries, e.g. Coffee from Kenya. Alternatively Kenyan industries can consider the opportunity costs of adopting new technologies that enable them to serve both local and international markets with innovative products.

Opportunity Cost theory in Microeconomics

You may learn the concept of opportunity costs in the course, foundations of economics, but the technical details are introduced in the decision-making theory in microeconomics. For example, household choices to consume goods and decision of firms to produce goods rely on the concept of opportunity costs. Those who are thinking of setting up a business will also try to select from several alternatives and weigh their advantages against each other.

Literature about Economics

The following Literature will help you to expand the spectrum of knowledge in this Field:

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