Opportunity cost

Key definition: Opportunity cost is the next best alternative foregone when a choice is made.

Why opportunity cost exists

Scarce resources normally have more than one possible use. Choosing one use means giving up the benefit that could have been gained from the next best use.

Core chain: scarcity -> a choice must be made -> one option is selected -> the next best option is foregone

Opportunity cost in different contexts

Decision-maker	Choice made	Opportunity cost
Consumer	Uses savings to buy a new phone.	The benefit of the next best item the savings could have purchased, such as a laptop.
Worker	Studies at university rather than working full-time.	The income and experience from the best available job foregone.
Producer / firm	Uses finance to buy new machinery.	The benefit from the next best investment, such as advertising or another shop.
Government	Uses land and tax revenue to build a railway.	The benefit from the next best public project, such as a hospital.

Opportunity cost and decisions

A government may choose a railway over a hospital if it expects the railway to create greater benefits i.e. reduced congestion, shorter journey times and increased economic activity. The opportunity cost includes the benefits the hospital would have provided.

Opportunity cost does not show that a decision is necessarily wrong. It makes the sacrifice involved clear, allowing decision-makers to judge whether their chosen use of resources provides enough benefit.

Common exam mistakes

Naming every rejected option instead of only the next best alternative.

Writing 'the money spent' without identifying what the money could otherwise have achieved.

Giving an unrealistic alternative that was not actually available to the decision-maker.

Describing a negative consequence of the decision rather than the benefit foregone.