What is Opportunity Cost?

by Investing School on April 5, 2010

Opportunity cost is a term that is used to describe the cost of a choice between two desirable choices and the accompanying results. The results are mutually exclusive. Another way to describe it is the benefits that you might have received had you made an alternate choice from your current plan of action.

Another way to understand this concept is through examples. Let’s say you made the choice to go to college. By making the choice to go to go to college, let’s say you are choosing NOT to work while you are in school. Your opportunity cost would be the wages not earned while you are in school.

Let’s look at another example. Say a farmer has chosen to grow beets instead of carrots. The farmer’s opportunity cost would be the crop that he did not choose and in this case they are carrots.

We all know that there are consequences to all the choices that we make every day. If you look at the example of the person that is going to college you can certainly acknowledge that there is an initial loss of income by choosing to go to school instead of working. However, most people who attend college increase their earning potential because of the knowledge and training they receive through their education. It is a risk but a calculated one.

In the case of the farmer, perhaps the farmer knew the purchasing habits of the buyers and local members of the economy in his area. Maybe he knew that beets were a better choice than carrots because of previous experience.

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