What Is Opportunity Cost? Example Explained
Learn what opportunity cost means in A Level Economics, why scarcity creates choices, and how to identify the next best alternative with clear examples.
Spec coverage: Cambridge International AS & A Level Economics 9708, Topic 1: Basic economic ideas and resource allocation, sub-topic 1.1 Scarcity, choice and opportunity cost, covering 1.1.1 (scarcity), 1.1.2 (choice) and 1.1.3 (opportunity cost).
Definition
Opportunity cost is the next best alternative forgone when a choice is made.
The fundamental economic problem is scarcity: resources are limited, but human wants are unlimited. Because resources are scarce, individuals, firms and governments must make choices. Every choice has an opportunity cost because choosing one option means giving up the best alternative.
The opportunity cost is not every alternative that is given up. It is only the next best alternative.
Example
Suppose a student has two hours available. They can either:
- revise Economics; or
- work in a part-time job earning $30{\char36}30$30.
If the student chooses to revise, the opportunity cost is the $30{\char36}30$30 they could have earned. The opportunity cost is not the enjoyment of watching a film, unless watching the film was the student’s next best alternative.
Similarly, if a government spends a limited budget on building a hospital, the opportunity cost could be the next best project it cannot fund, such as improving public transport. The opportunity cost is therefore a real cost of the decision, even though no money may be paid directly for it.
What determines opportunity cost?
Opportunity cost depends on the alternatives available and their value to the decision-maker. It can vary between people and can change over time. For example, a student may value earning income more during a holiday than during the examination period.
Opportunity cost can also apply to firms. If a factory uses its resources to produce cars, the opportunity cost is the output of the next best product those resources could have produced.
Common mistake
Do not define opportunity cost as simply “the cost of a choice” or “all the things given up”. For an accurate A Level definition, state that it is the next best alternative forgone.
