When the term “opportunity cost” comes up, a lot of people are at a loss. What you need to know, however, is that this term is just a fancy wording of “trade-off.”
Basically, when you are making a decision, you also have to consider the trade-off. You need to think about what you’ll be receiving, but also what you’ll have to give up in order to have that opportunity.
Put as simply as possible, the opportunity cost is a hypothetical question: what could I have done with that money had I not used it on my first choice? What did this cost me? Still, not all opportunity costs are the same, so you need to get a deeper understanding of this fancy word phrase.
Explicit vs. Implicit Opportunity Cost
Most economists prefer breaking the opportunity cost into two categories: explicit and implicit. Rather than explaining it to you, here are some examples that will help you understand the concepts.
Explicit Opportunity Costs
Let’s say that you have a nice bar and you want to add some extra drinks to the menu – drinks that would require you to pay an extra $30 in ingredients, labour, water, electricity, and so on.
The explicit cost is what you could have done with those $50 had you decided NOT to add that drink on the menu. You could have chosen to pay your bills, give it to charity – or simply use it to add a completely different item.
Implicit Opportunity Costs
Let’s say, for example, that you have a summer house that you only use every now and again, for a few days, during your holidays. The implicit opportunity cost is the money you could have gathered over the months, had you chosen to rent the house instead of keeping it for your own occasional benefit.
Going Beyond Business
The opportunity cost may revolve around the question “what if,” but at the same time, it does not only have to mean business. It can also be a matter of feelings and personal values.
For example, let’s say that you love cooking more than anything else, but it pays better to be a doctor. This doesn’t mean that you’ll have to go to medical school simply because you’ll have a better salary.
Each choice you make will always have a consequence; you just have to make sure that you accept those consequences. There’s not really a point wallowing in the “what ifs,” since the cards have already been set.
Opportunity Cost in Decision Making
The opportunity cost is strongly connected with every decision you ever made in your life, and the actions that occur after that. Each action is also traded for another one.
For example, if you chose to eat at a certain restaurant, you can’t go to another one at the same time. There’s only one of us, and we can’t be in both places at the same time. Therefore, we will be trading an experience, a result, with another. Everything in life is basically an opportunity cost, and all we have to do is learn to accept it.