One of the fundamental ideas derived from the concept of scarcity is that every decision that we make has a cost associated with it. Economists call this cost the opportunity cost and it’s defined as the alternatives that we forgo when making a choice. Each action that we take drains away from the available resources we have, depriving us of the benefits of the other things those resources could have been used for.
If you have $100 in your pocket and you decide to use that money to buy shoes, you give up all the other things you could have used that $100 on. Instead of shoes, you could have bought $100 worth of food, movies, games, etc. You also could have saved the $100 and gotten interest from the savings. All the alternatives that you gave up for buying shoes are referred to as the opportunity cost.
The concept of opportunity cost isn’t limited to just money either. Every day we have to make a decision as to what to do with our time. Every morning (or evening for you night owls) when you wake up, you are presented with a choice: get up or stay in bed. If you get up and start your day, you give up any extra sleep/rest you might have gained by staying in bed. If you stay in bed, you give up the extra time you could have spent preparing for work, watching a morning cartoon, or running naked around the house singing the latest Katy Perry song (I don’t know what it is that you do in the morning). These choices and costs are everywhere we go and it’s something that we deal with on a daily basis.
Pop quiz: Suppose you’re presented with the following problem: You’re in the final months of your high school career, just about to graduate. You’ve been accepted into your dream college, the University of (website name) as an undergraduate economics major. You expect to complete your degree requirements in four years and the total cost of your educations going to run you $45,000. At the same time, you have an uncle who owns his own business and since he knows you’re a hard worker, is willing to hire you to work for him as a receptionist for $40,000 a year.
What’s the opportunity cost of going to college?
What’s the opportunity cost of going to work for your uncle?
Going to college: If you decide to get your undergrad degree in economics, your opportunity cost is the $45,000 in tuition plus the $160,000 in income you could have earned by working for your uncle in the four years you spent studying.
Working: If you decide to work for your uncle instead, the opportunity cost is all the potential higher income that you could have earned from other jobs with a bachelor’s degree. The higher income isn’t guaranteed, but people with college degrees tend to earn more money over their lifetimes than those who don’t.
Most of the time when I present this problem to people, they think the opportunity cost of going to college is just the $45,000 they have to pay in tuition. What most people forget about is the extra $160,000 they could have been earning instead of going to school, which is a decent chunk of change in my opinion. The point I wanted to illustrate with this problem is that opportunity cost includes all of the alternatives that are forgone, not just the money that comes out of your pocket.
McConnell, Campbell R., Stanley L. Brue, and Sean Masaki. Flynn. Macroeconomics: Principles, Problems, and Policies. Boston: McGraw-Hill Irwin, 2009. Print.
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