An opportunity cost is the value of the next best alternative that is forgone when a decision is made to choose one option over another. It represents the potential benefits, profits, or returns that are missed out on by not selecting the alternative choice
. In practical terms, opportunity cost can be understood as what you give up in terms of money, time, or resources when you allocate them to a particular activity instead of the best alternative use. For example, if a company invests in new equipment rather than putting the money into the stock market, the opportunity cost is the return it could have earned from the stock market investment
. Opportunity cost is a key concept in economics and business decision-making because resources are limited, and every choice involves trade-offs. Considering opportunity costs helps individuals and organizations make better, more profitable decisions by weighing the benefits and risks of each option
. A simple formula to calculate opportunity cost is:
Opportunity Cost=Return on best alternative−Return on chosen option\text{Opportunity Cost}=\text{Return on best alternative}-\text{Return on chosen option}Opportunity Cost=Return on best alternative−Return on chosen option
This quantifies the difference in expected returns between the chosen option and the next best alternative
. In summary:
- Opportunity cost is the forgone benefit from not choosing the next best alternative.
- It includes both explicit costs (direct monetary costs) and implicit costs (like time or lost opportunities).
- It is used internally for strategic decision-making and is not usually reflected in accounting profits
