Opportunity Cost

Definition

Opportunity cost is the cost of an alternative that must be forgone to pursue a certain action, representing the benefits that could have been received by taking an alternative action.

Purpose

Opportunity cost helps in decision-making by comparing the potential returns of different choices. It ensures that resources are allocated efficiently by considering the foregone benefits of not choosing the next best alternative.

Examples of Use

• Investment Decisions: Choosing to invest in one stock over another and considering the potential returns of the forgone stock.
• Business Strategy: Deciding to launch a new product instead of investing in improving an existing one.
• Personal Finance: Opting to spend money on a vacation rather than saving or investing it.

Related Terms

• Cost-Benefit Analysis: A process of comparing the costs and benefits of different options.
• Marginal Cost: The cost of producing one additional unit of a good or service.
• Sunk Cost: Costs that have already been incurred and cannot be recovered.

Notes

• Decision-Making: Opportunity cost is crucial in making informed and rational economic decisions.
• Evaluation: Always evaluate the potential returns of all alternatives before making a choice.