Opportunity cost is one of those terms that economists love to toss about the place. It sounds complicated, but opportunity cost is a really simple concept.
Ready? Here goes: opportunity cost is what you would have gotten if you’d done the other thing: the thing that you didn't do.
Take that famous conundrum: You come to a fork in the road, and decide to go left. The opportunity cost of that decision is what you would have gotten if you’d gone right.
For businesses, it’s all about money. Imagine a computer company named, say, Strawberry. Strawberry builds its business to the point where it has to make a decision: should it be a software company making applications, or should it be a hardware company and make computers?
Tough choice: it’s really good at building computers, and it makes good money at it. But there’s could be more money in software.
Strawberry runs all the numbers and decides to become a software company. Why? Because it reckons it can build a more profitable business making software. Fair enough. But the opportunity cost of that decision is the money it would have made had it decided to keep building laptops.
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For consumers, it’s a little different, and the opportunity cost of a decision may not be financial at all. Imagine you’re at that fork in the road again. One road leads to the city -- the other road to a seaside town. If you decide to turn left and go to the city, the opportunity cost is what you would have gotten if you turned right: you missed out on all that great weather, sand between your toes, ice cream, oh, and a heck of a lot less stress.
It seems obvious, right? And almost way too simple. So why do people make such a big deal about opportunity cost? Because it’s an essential component of decision making.
Considering opportunity cost forces you to weigh the real stakes of your choices. And helps you make the best of your options.
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