Opportunity Cost is the cost of an alternative that must be forgone in order to pursue a certain action. Put another way, the benefits you could have received by taking an alternative action. It refers to the value forgone in order to make one particular investment instead of another. These are a factor not only in consumer decisions, but in production decisions, capital allocation, time management, and lifestyle choices. The difference in return between a chosen investment and one that is necessarily passed up.
Say you invest in a stock and it returns a paltry 2% over the year. In placing your money in the stock, you gave up the opportunity of another investment; say, a risk-free government bond yielding 6%. In this situation, your opportunity costs are 4% (6% – 2%). The opportunity cost of going to college is the money you would have earned if you worked instead. On the one hand, you lose four years of salary while getting your degree; on the other hand, you hope to earn more during your career, thanks to your education, to offset the lost wages. It represents the benefits an individual, investor or business misses out on when choosing one alternative over another. These cost analysis also plays a critical role in determining a business’s capital structure.
