When people hear the word "cost," they usually think of money. Going out for lunch will cost me $10. Going to the park won't cost a dime. Going to college will be more expensive than I want to think! In reality, each of these choices costs more than the dollar amount, because it involves giving up time, money, or resources that could be used to do something else. In short, each choice has an opportunity cost.
Opportunity cost is a key economic concept. Because resources are scarce, choosing one opportunity means giving up something else. Whether it be money, objects, experiences, or even emotional pleasures, opportunity cost is the cost of giving up one thing in favor of another. More precisely, economists define opportunity cost as the highest valued alternative given up to pursue any given action.
The idea of opportunity cost has been discussed in economic theory as early as formative economist Richard Cantillon. In his eighteenth century Essai sur la Nature du Commerce en Général, he noted that a farmer giving up his son to apprenticeship would lose several years of valuable labor. In 1848, Frédéric Bastiat noted the opportunity cost of a broken window. Economist David Green later distinguished opportunity cost from the "pain cost" of labor, suggesting that higher wages reflect a higher personal opportunity cost, not necessarily harder work. Friedrich von Wieser, of the Austrian School of economics, discussed the business man's need to weigh sacrifice and foregone alternatives; and Milton Friedman of the Chicago School frequently commented that there was no free lunch, i.e., everything costs, even if no currency is exchanged.
Opportunity cost applies to every area of life. If a farmer plants a field of corn, he cannot plant the same field with soybeans. A person buying a TV cannot use that money to eat out. For someone attending a sports event, the opportunity cost may be passing up a visit to the mall, a trip to the movies, or the completion of a weekend home-improvement project. A student giving up four years of life to go to college must pay tuition plus lose the salary and experience that could have been gained by working.
Governments also face opportunity cost. Only a limited number of programs can be funded, so officials must decide where to spend tax dollars. Will they spend money on roads or the arts? On college grants or food stamps? On military supplies or Social Security? One author points out that despite limited resources, special interests tend to ignore the opportunity cost of their particular programs. They encourage the government to overlook these important costs by touting their programs as invaluable. On the flip side, government spending cuts are not always good for private jobs and the economy.
While accepting the idea of opportunity cost, the Keynesian School of thought believes it is possible for idle resources to hold no opportunity cost, i.e., individuals have no incentive to use them productively. Therefore, government must intervene in the market to get idle resources moving. This idea was previously addressed by 19th century economist Frédéric Bastiat in his treatise on What Is Seen and What Is Not Seen. His Broken Window Theory tells the story of a boy breaking his father's window. The accident results in business for the glazier, which at first glance seems positive. However, Bastiat explains the money could have been used for something else—for example, shoes or books—if the window had not been broken. In effect, the opportunity cost of having to fix a broken window was to forego the shoes or books. In this case, unused resources may not be as idle as they look, and stimulating the economy by government projects may only redirect resources from more important needs.
Opportunity cost has many hidden angles and implications. Understanding the concept is an import skill for making wise choices in life, from everyday decisions on how to use time to far-reaching choices on how the government's money should be spent. This topic provides a basic explanation of the term along with case studies of how it applies to multiple of areas of life.