When I first learned about the term, 'opportunity cost' in high school, I simply rote learned, 'it is the cost of giving up the next best alternative', which sounds pretty technical and confusing but one of the easiest concepts in economics and business studies. The idea applies to everything that requires making a choice in life:
- Buying a car or a bike,
- Buying a blue bike or a black one,
- Ordering chicken or beef at a restaurant,
- Going camping or swimming.
The list goes on, because we make hundreds of choices each day!
How does the idea of opportunity cost come in?
When you evaluate two or three different options, you try to weigh their costs and benefits against one another to figure out the right choice. It's a hot day and you want something refreshing- ice cream or lemonade?
You know that ice cream tastes great but has more calories and you're not too happy with your weight. Lemonade is healthy and hydrating, but it lack the sweetness of ice cream which you enjoy so much.
After much thinking, you choose lemonade.
When you're done with the decision, you might regret not choosing the 'other' option because of the benefits you missed. You see a kid walk by eating the very ice cream cone you considered buying and you think about the ice cold sensation and oh-so-sweet taste you missed out on.
That, is your opportunity cost for buying lemonade.
Why do I say, 'your opportunity cost'? Because this cost is different for everyone. My opportunity cost for lemonade may be a milkshake, because ice cream just doesn't appeal to me. My 'next best alternative' is milkshake, while another person's may be fruit juice.
It's kind of hectic determining the opportunity cost for everything, isn't it? Yes. It'll waste time and be mentally taxing if you analyzed everything this way. That's why this idea is mostly used in business situations where the opportunity cost is more drastic. Often, business decisions require choosing between:
- Different factory building locations,
- Different product enhancements,
- Expanding in various markets across the country or world.
That's not to say you can't apply this idea on a smaller, personal scale. Next time my mum bakes a delicious cake, I'll consider whether I should eat it all up (at the opportunity cost of not eating it the next day) or save some for later (at the cost of no immediate satisfaction).