Opportunity cost is the value of the best alternative forgone when making a choice. It applies to both business and personal decisions, and can be used to determine the best alternative. For example, if a company chooses to produce diapers instead of wipes, the opportunity cost is the potential sales from wipes. Similarly, if a consumer chooses to buy diapers instead of wipes, the opportunity cost is the price of the wipes. Opportunity cost can also be applied to personal decisions, such as choosing not to act on inspiration to write a song.
Choice and opportunity costs are related to the extent to which opportunity cost relates to the price of a choice made based on a set of available options. This means that opportunity cost is derived by evaluating the value of one choice in terms of another choice having to be lost because of the one selected. Choice and opportunity costs can be viewed from a business perspective; however, this concept of choice and opportunity also applies to personal decisions.
An example of choice and opportunity cost can be seen in the case of a business in terms of choices that entrepreneurs, CEOs, and corporate executives must constantly make in the natural course of running a business. For example, if a company has the facility to produce baby diapers or baby wipes, the opportunity cost can be determined by evaluating the cost of the selected choice. If wipes and baby diapers have the same cost of production and the firm chooses to produce the diapers, the opportunity cost can be derived by valuing the cost of the decision to produce diapers instead of wipes. Assuming the company would make $1,000,000 in annual sales from wipes, while sales from diapers translate into $800,000, the opportunity cost of manufacturing the diapers would be $200,000.
The same concept can also be applied to consumers. If a consumer goes to the store to buy the diaper or baby wipes, the opportunity cost is calculated by evaluating the relative price of the confiscated item in relation to the chosen item. Thus, if the price of a box of diapers is $15 and the price of a box of baby wipes is $5, the opportunity cost of buying a box of diapers is three boxes of baby wipes, or $15. Using the concept of opportunity cost when analyzing different choices allows a business to decide which is the best alternative.
In a more personal application, choice and opportunity costs can be derived from the various choices individuals make every day. Assuming an individual is inspired to write a song but chooses to do nothing, letting the momentum of inspiration pass, the opportunity cost can be analyzed by controlling for the benefit lost through choosing not to act. If the song became a triple platinum selling, Grammy winner, then the opportunity cost would include factors such as lost sales, Grammys, and recognition versus the decision not to act.
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