How is "opportunity cost" an useful concept? Even when it does exist?

What use does it serve?

  • $\begingroup$ Since you have discovered the opportunity-cost tag, have you considered looking at those questions to see if they provide any insight? $\endgroup$ – Giskard Jun 6 '18 at 12:04
  • $\begingroup$ @denesp In some aspects yes. $\endgroup$ – mavavilj Jun 6 '18 at 12:28

Probably the most useful aspect of the concept of "opportunity cost" is to distinguish between choice problems where a particular choice is available, but the alternatives differ. The concept of opportunity cost stresses that when we make a choice of some action, we forego alternatives, and so the gain from that action is the difference between the benefit of that action, and the benefit of the next-most-preferred alternative.

For example, you might have two choice problems (e.g., two nights of the week) where you have the opportunity to go to the movies on your own. You get a certain amount of enjoyment from this, and so you might consider making this decision by thinking about how much you enjoy this activity. The concept of opportunity cost would tell you to bear in mind the available alternatives, so that you remember you are foregoing other possible activities if you choose to go to the movies. In one of these cases (e.g., the first night) you might not have any exciting alternatives, and so going to the movies is pretty attractive (the opportunity cost is low). However, on another night, you might have been invited to an exciting party, with lots of close friends, and so now going to the movies and missing the party seems like a relatively bad idea (the opportunity cost is high).

All that "opportunity cost" is really doing is reminding you of the fact that decision problems must be considered on the basis of all the available actions, and the relative value of the optimal action is affected by the value of the best foregone alternative. Most people understand this implicitly (for the most part), but economists are particularly aware of this, and have developed a concept around it.

One consequence of considering opportunity cost is to highlight the sunk cost fallacy, where a person makes a decision to pursue some action even though it is less desirable than the available alternatives, because they have already committed resources to that course of action, and they do not wish to accrue losses from a change of action (i.e., they have loss aversion). In the example above, suppose you had already pre-paid for your movie-ticket before you find out about the party, and you can't get a refund. The payment you made for the ticket is a "sunk cost". You might be inclined to go to the movies, and miss the party, just so that you don't "waste" the money on the ticket. However, doing this would just compound one mistake (buying the ticket) with another mistake (choosing to see the movie over a party you would have enjoyed more). The concept of opportunity cost tells you to compare the available actions against the alternatives, noting that the sunk cost occurs under every case (and is therefore not relevant to a particular action).

  • $\begingroup$ So are you saying that it's more of a microeconomic/household/company thing than a nation-wide macro thing? $\endgroup$ – mavavilj Jun 8 '18 at 5:12
  • $\begingroup$ Not really - the concept of opportunity cost arises in any decision problem where we face alternative possible courses of action. This could arise at the level of an individual, a household, a business, or a large institution. The example I chose to illustrate the concept is of a small decision, but the concept applies more broadly than this. $\endgroup$ – Ben Jun 8 '18 at 8:17
  • $\begingroup$ I've found that economists are more often concerned about arguing why e.g. their class should have the most resources, rather than "helping people out". That is why I speculated that whether opportunity cost could be used to argue for exploitation of labour or something. "Hey we can't pay you more than this in wages, because of opportunity cost", "We need more subsidies, because of opportunity cost". $\endgroup$ – mavavilj Jun 8 '18 at 11:42
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    $\begingroup$ @mavavilj Sorry we could not confirm your anti-economist bias :( $\endgroup$ – Giskard Jul 8 '18 at 20:14

As Ben has correctly specified, the opportunity cost is defined in terms of "what am I giving up? ". In a microeconomic sense, If as a household I decide to save for my kid's college then my opportunity cost is giving up on vacations, weekly dinners, new car, etc. For a student, the opportunity cost of not going to class is the attendance marks that she is giving up in addition to the lecture notes and knowledge. The concept of opportunity cost helps us make decisions. It represents a tradeoff between competing interests of the same decision-maker.

For example, why do athletes take one or two extra years to graduate? This is because for them the cost of sitting through a class is much higher than a regular student - since they could have been practising instead which can reap them higher payoffs in the field. Here the same decision-maker: the athlete is deciding between her competing interests of graduating college and becoming a world-class player.

However, this is an important concept in macroeconomics too. Say for example - the Philips Curve. It represents a tradeoff between unemployment and inflation. So the opportunity cost of low inflation is having high unemployment in the country. Another example will be the tradeoff between spending on defence goods and civilian goods. Each extra dollar that the Indian government spends on bullets and ammunitions is taking away a dollar from the education and health sector budget. Another classic tradeoff is between present incomes and environment conservation.


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