Opportunity Cost

What Is Opportunity Cost?

Opportunity cost is the value of the best alternative forgone whenever a choice is made. Because resources are scarce, every decision to use time, money, or materials one way means giving up their next-best use, the idea captured by the phrase "there is no such thing as a free lunch," popularized by Milton Friedman. Opportunity cost includes more than out-of-pocket spending. The full cost of attending college full-time, for instance, counts not only tuition and fees but also the wages the student gives up by not working. This is why economists distinguish explicit costs, which involve actual payments, from implicit costs, the value of forgone alternatives with no cash changing hands.

Why It Matters

Opportunity cost is arguably the central idea in all of economics, because scarcity forces trade-offs on every decision-maker. It reshapes how costs are measured: economic profit subtracts both explicit and implicit costs from revenue, so a business earning normal profit of zero economic profit is exactly covering the opportunity cost of its resources. Opportunity cost also underlies comparative advantage, since a producer should specialize in the good it can make at lower opportunity cost, and it is what the slope of a production possibilities frontier measures at every point. From choosing a career to allocating a national budget, thinking in terms of opportunity cost keeps attention on what is truly sacrificed, not just what is paid in cash.

Test Your Knowledge

Questions on this topic from the EconRecall fact bank:

• What does it mean for a producer to have a comparative advantage in making a good?
  They can produce it at a lower opportunity cost than the other producer
• In AP Microeconomics, if a worker can produce either 4 chairs or 8 tables in a day, what is the opportunity cost of producing one chair?
  2 tables
• In AP Macroeconomics, for both parties to benefit from trading two goods, where must the agreed terms of trade fall?
  Between the two parties' opportunity costs of producing the good