Opportunity Cost, an Overlooked Concept of Economics

Economics provides basic but useful concept for us in terms of comparing several alternatives before deciding, which is named opportunity cost.

For me, I can say that after I started to asses situations considering opportunity cost, it really make me behave more rational. I used to evaluate a situation or an opportunity solely by considering it's benefits it will bring, however by choosing I also reject many other alternatives that I can do with the same resources I have. What opportunity cost is trying to assert is that before making decisions evaluate all the alternatives that you have with the same resources and capabilities. Then try to minimize opportunity cost, which is simply subtracting the benefits that you get from the benefits that you would have get lf you choosed the second best alternative.

Opportunity Cost= Return on the Best Option Not Chosen- Return on the Option Chosen

For example, I have three options

I can go out with my friends, which will cost roughly 20$

I can work in restaurant and earn 30$

Now the only thing matters is my objective, my needs. If I am in shortage of money, then choosing the last option makes sense because it minimizes opportunity cost. When I choose second option my opportunity cost will be (-20)-30=-50

If I choose second then

30-(-20)= 50

So if my objective is spending cost-effectiveness night then working in a restaurant makes more sense.

However, if your objective is to spend a fun night, fulfill your happiness then you should compare the happiness that these alternatives will bring you and then decide accordingly.

Opportunity Cost in Business Context

Although financial reports do not indicate the opportunity costs specifically, business owners often use the concept to make better decisions when they have multiple options before them. "Bottlenecks, for instance, are often a result of opportunity costs." [1]

We can use this concept, for example, when we are trying to choose the best strategy while making investment decisions. Assume you have 12,500 TL at the beginning of year 2020 and would like to invest your money. Your goal is to maximize your total amount of money at the beginning of year 2023. You have the following options:

With these options, you can invest your money in numerous ways. You can invest the total amount of your money to Option 3 and get (1.38)12500= 17250 TL at time t+3 (2023) or solely choose option 2 and get (1.12)^3*12500 and get 17561.6 TL. Let's say you only consider these two options. Then,when you decide the first one rather than second one, your opportunity cost will be the return of the forgone option minus the value of the option you choose.

If you are not limited with these options only, then you have to find the optimal slution to the problem. For this example, best solution can be found by using Linear Programming Model which I will discuss in the Industrial Engineering section later. Finding the optimal solution to problem then you can evaluate your opportunity cost by calculating the Return on the Best Foregone Option minus Return on Chosen Option.