Economics: Opportunity Cost

We have already talked about the definition of economics, about macroeconomics and microeconomics, about the laws of supply and demand, and how they work together. Now, let’s look at another basic economic idea: Opportunity Cost.

Opportunity Cost means this: if we want to buy something or spend time on something, then it means that there is something else that we are not buying or spending time on. Confusing? Let’s look at an example.

Say a student is trying to decide between buying a chocolate bar and a milkshake. He only has money enough to buy one of them. If he buys the chocolate bar, he won’t be able to buy the milkshake. In the same way, if he buys the milkshake, he won’t be able to buy the chocolate bar. The cost of the chocolate bar is equal to the money he pays for it. The Opportunity Cost of the chocolate bar is equal to the milkshake that he gave up.

Now, how does this relate to economics? First, remember that economics is the efficient allocation of scarce, or limited, resources. The student has limited money, so he can only buy one thing at a time. In economics, any time resources are used for one thing, there is an opportunity cost of something that they can’t do anymore.

In macroeconomics, this talks about how nations try and decide what is more important to spend their resources on at the moment. For example, the government can either build more classrooms, or raise teachers’ wages. If it builds more classrooms, the opportunity cost will be that teachers will not get a raise. It works the other way around as well.

In microeconomics, it works for families as well. If your family decides to go the beach for the weekend, the opportunity cost is that you don’t go to Disneyland. If your family decides to go to Disneyland for the weekend, the opportunity cost is that you don’t go to the beach.

How about the Laws of Supply and Demand, how do they fit in here? Remember, the Law of Demand says the cheaper something is, the more people will want to buy it. In our bottled water example, every student who buys water is paying an opportunity cost for it. The more expensive the water gets, the less students want to pay the opportunity cost. Instead, water becomes the opportunity cost, because students spend the money on something else.

In the Law of Supply, the more expensive something is, the more people will want to sell it. But the more expensive the bottled water is, the more students cannot buy it. So a seller who sells the water at 50 dollars has an opportunity cost of all the students who do not want to buy water at that price. But a vendor selling water at 5 cents has an opportunity cost of the extra money he could have earned from a higher price.

To review, the opportunity cost of something is whatever you give up for it. The opportunity cost of buying one book is that you can’t buy another. The opportunity cost of buying one puzzle set is that you can’t buy a book. The pattern does not change.

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