1.
3 Opportunity Cost
1.3.1 Definition of Opportunity Cost
Opportunity cost is the loss of the next best alternative when making a
decision
Formula for Calculating Opportunity Cost
Opportunity Cost=FO−CO, where: FO=Return on best forgone option
CO=Return on chosen option
Due to the problem of scarcity, choices have to be made about how to
best allocate limited resources amongst competing wants and needs
There is an opportunity cost in the allocation of resources
When a consumer chooses to purchase a new phone, they may be unable to
purchase new jeans. The jeans represent the loss of the next best
alternative (the opportunity cost)
When a producer decides to allocate all of their resources to producing
electric vehicles, they may be unable to produce petrol vehicles. The petrol
vehicles represent the loss of the next best alternative (the opportunity cost)
When a government decides to provide free school meals to all primary
students in the country, they may be unable to fund some rural
libraries which may have to close. The libraries represent the loss of the next
best alternative (the opportunity cost)
1.3.2 The Influence of Opportunity Cost on
Decision Making
An understanding of opportunity cost may change many decisions made by
consumers, workers, firms & governments
Factoring the opportunity cost into a decision often results in different outcomes &
so a different allocation of resources
1.3 Opportunity Cost 1
Examples of How The Consideration of Opportunity Costs Can Change Decisions
Stakeholder Example
- Ashika is wanting to visit her best friend in Iceland
- She looks at flight prices from London to Reykjavík
- On Friday night it costs £120 whereas Thursday night is only £50
- She is about to book the Thursday flight but then realises that the opportunity
Consumer cost of saving £60 on a flight is the inability to work on Friday (loss of £130
income)
- Ashika books the more expensive flight. If she had booked the cheaper flight,
it would have cost her the income from the missed day of work (£130) + £50
for the ticket
- Ric has been offered two jobs & is deciding which one to accept
- Job A offers £400 a month more in salary than Job B, but Job B offers the
flexibility of working from home
- Most people would only consider the actual cost of commuting before they
make a decision, which in Ric's case is £40 a week or £160 a month
Worker
- Ric values his free time & decides that each hour he can save in commuting
is worth £20 to him (£180 a week) - he is considering the opportunity cost of
commuting
- Ric decides to take Job B as the cost of monthly travel (4 x £40) and value of
the lost hours spent commuting (4 x £180) adds up to £880 a month
- A firm selling organic avocados is offered a supply contract by a large
supermarket who wants to buy all of their stock each month, but at a low price
- The supermarket is a prestigious customer
Firm
- The firm decides to not accept the contract as the loss of prestigious
customer is worth less than the lost revenue to existing customers (opportunity
cost)
- The Australian Government has entered into a contract with France to supply
them with 8 submarines valued at $70bn
- The USA hears about it & pressurises Australia to buy the submarines from
them instead
Government - The Australian Government considers the opportunity cost of denying the
USA which includes less preferential deals on other military hardware &
general trade agreements
- They decide to break the contract with France & view this as the approach
that carries the lowest opportunity cost
1.3 Opportunity Cost 2
