Introduction to Economics

Opportunity Cost

Central to your understanding of Economics is an understanding of this key term: Opportunity cost. If you go on to study Economics at university, you will discover that this one key idea is the basis of an entire semester of work. For now, we will keep it relatively simple.

The term opportunity cost is related to our ability to make choices with our scarce resources. Let’s consider the example from the previous page. At that time, we considered what you might choose to do with a block of land in the central business district. To remind you, your options were:

1. Selling the land
2. Building a car park
3. Building an office block, or
4. Creating a school or hospital

Let’s imagine that you decided to go ahead and build the office block, because you believe that is the one that will provide you with the best financial return. Once you have made that choice, you can’t have any of the other options. The opportunity cost is the value of the second best alternative. It is the opportunity that you “gave up” in order to have the option that you considered to be the most desirable.

At a very simple level, the concept of opportunity cost is used every day. When you go to buy your lunch at the school canteen, if you choose to eat a salad roll, then you are giving up the opportunity to eat a meat pie. The value of the meat pie (the second best option) is your opportunity cost.

There are two final things that you should understand about opportunity cost. The first is that it applies to every decision that you make. For example, if you choose to sit in the park and read a book, you can’t use the same time to have a driving lesson. If you choose to study Commerce at university, you can’t use the same time to get a full time job. Every time you make a decision, you are giving up the opportunity to do something else.

 And finally, opportunity cost does not need to be measured in dollars. You will explore this idea in more detail in Unit 2 when you look at the theory of comparative advantage in international trade. For now, a simple example will be sufficient.

Imagine that I own some timber – this is a capital resource. (The tree was a “land” resource. Once I have completed some work with the tree, such as chopping it down and refining it into timber, it becomes a capital resource.) I can use this timber to make four chairs, or one table. If I choose to make the chairs, then I must give up on the idea of making the table. The opportunity cost of four chairs is the one table that I have to give up.

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