Opportunity Cost

What you would be doing, if you weren’t doing this!: No matter what choice we make, there is an opportunity cost, or next-best alternative that must be sacrificed. Every time we make a choice we experience an opportunity cost. The key to making the best possible decision is to minimize your opportunity cost by selecting the option that gives you the largest benefit.

Real World Examples

Pizza or wings?

Imagine a two-good economy, which produces pizza and wings. Now make the further assumption that this economy has only two people. One person is good at making pizzas and the other is better at making wings. When this is the case, the potential gains from trade are clear. Each person will specialize in what he or she is good at producing and trade in order to acquire some of the other good being produced.

There are two people in our economy: Debra Winger and Mike Piazza. If Debra devotes all of her work time to making pizzas, she can produce 60 pizzas. If she does not spend any time on pizzas, she can make 120 wings. On the other hand, Mike can spend all his time on pizzas and produce 24 pizzas or all his time on wings and produce 72 wings.
To franchise or not to franchise

A business can choose many different courses of action, but choosing one direction, precludes another. For instance, buying a McDonald’s franchise costs about $1,000,000. That considerable investment has an opportunity cost. The money could have been used to do something else, perhaps opening up another fast food restaurant, or starting an entirely different business, or it could have been invested in the stock market, or even placed in the bank where it would earn interest each month.

A good economist is concerned about how the $1M could have been spent and what it would have earned if it had not been spent to buy the McDonald’s franchise.

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