What Is Opportunity Cost? Examples, Calculations, and Sunk Costs

Opportunity cost is the value of the next-best alternative you give up when you make a choice. It can exist even when you spend no money, because using your time or space for one activity can prevent another use. To compare choices, identify realistic alternatives and evaluate their benefits and costs over the same period.

What is opportunity cost?

Opportunity cost arises because money, time, and other resources are limited. Using a resource for one purpose can prevent you from using it for another. The Federal Reserve Bank of St. Louis's explanation of opportunity cost focuses on the next-best alternative forgone when a decision is made.

Suppose you decide to spend Saturday afternoon studying. You give up activities you could have done during those hours, such as paid work or a walk. If the walk would be your preferred alternative, its rest and enjoyment are the opportunity cost of studying. Someone who would prefer to work may have a different next-best alternative.

Do not add up the value of every activity you forgo. If you could not both work and take a walk during the same hours, you would not have received both benefits by skipping your study session. Use the best alternative you would actually have chosen as the basis for comparison.

How do you calculate opportunity cost?

Distinguish the next-best alternative from the difference between options

Consider this hypothetical example. You can accept only one of three jobs, each requiring six hours on the same day. The amounts below are what you would receive after subtracting cash expenses. Assume there are no differences in difficulty, risk, or satisfaction, and compare only the financial results. All amounts are in South Korean won (KRW).

If you choose A, the best alternative you forgo is B. The opportunity cost of choosing A is therefore ₩80,000. It is not the combined ₩130,000 from B and C, because you could not perform both jobs.

Subtracting B's ₩80,000 from A's ₩120,000 gives ₩40,000: the additional amount you receive compared with the next-best alternative. That difference is distinct from the opportunity cost itself. Automatically subtracting two returns whenever a question asks for opportunity cost can produce the wrong answer.

Include cash expenses and implicit costs where relevant

When assessing an activity's total economic cost, it can help to distinguish explicit costs and implicit costs. Explicit costs are actual payments. Implicit costs reflect the value forgone by using your own time or resources rather than putting them to another use. See OpenStax's explanation of explicit and implicit costs for this distinction.

Suppose a one-day course requires a ₩50,000 fee and ₩10,000 in travel expenses. On the same day, you could actually accept a job that would pay ₩80,000 after its related expenses. Assume that job is your best alternative to the course and there are no other costs.

• Explicit costs: ₩60,000 for the course fee and travel
• Implicit cost: ₩80,000 in net income forgone by declining the job
• Total economic cost of attending: ₩60,000 + ₩80,000 = ₩140,000

This comparison accounts for the alternative uses of both the cash and the time committed to the course. The earlier A, B, and C example instead compared income figures that already had cash expenses deducted. Check your calculation basis so you do not count an expense or forgone income twice.

An economic cost of ₩140,000 does not mean attending the course is necessarily a bad choice. You can also consider the learning, enjoyment, and potential future use of the material. If rest would be your best alternative that day, the alternative changes too: the job's ₩80,000 cannot automatically be treated as everyone's opportunity cost.

Choices without cash payments can still have opportunity costs

A free talk may charge no admission but require three hours of travel and attendance. If your preferred alternative would be spending that time with your family, that forgone time has value. A zero admission price does not eliminate every cost.

The same principle applies to things you already own. Using your own equipment requires no rental payment to someone else, but it may mean giving up the net income you could have earned by renting it out for the same period. You should not assume an arbitrary rental income if no realistic customer or rental arrangement is available.

You do not have to express every value in money. For rest, relationships, or learning, describing what you would give up can be useful even without an exact price. Nor should you automatically value every hour at your normal wage: first check whether you could actually work additional hours then and whether that would be your preferred alternative.

How does opportunity cost differ from a sunk cost?

Opportunity cost concerns the alternative you would give up through your current choice; a sunk cost has already occurred and cannot be recovered through that choice. The concepts address different parts of a decision.

Buying a nonrefundable course does not mean you must spend your remaining time on it. Compare the value of the remaining lessons with what you could do during the same hours, separately from regret about the payment. The article on sunk costs and how to evaluate your options explains how to distinguish recoverable amounts and the costs of stopping.

How to apply opportunity cost to a real decision

1. Define the decision and timeframe. Replace a broad question such as "Should I study?" with "Should I use six hours this Saturday for a course or a job?" A consistent timeframe prevents you from comparing one option's daily income with another option's monthly results.
2. List realistic alternatives. Distinguish options you can actually choose from courses with closed enrollment or work you have not been offered. If extra work is unavailable that weekend, do not automatically treat your usual hourly wage as income you would forgo.
3. Compare additional benefits and costs on a consistent basis. Consider cash expenses, time, fatigue, satisfaction, and risk. If you have calculated income after cash expenses, do not subtract those expenses again. Also check whether a cost would be identical under every option and therefore would not affect their relative appeal.
4. Identify the single best alternative you would otherwise choose. Imagine that your selected activity were unavailable. What would you actually do instead? That is the next-best alternative, and its value provides the basis for comparison.
5. Distinguish forecasts from preferences before deciding. Check how certain the available earnings or course benefits really are. A high expected return may be less attractive when it is uncertain or requires giving up rest you value more.

Considering opportunity cost does not require choosing the activity that earns the most money at every moment. It helps you explain, concretely, "What am I giving up through this choice, and is this option still more valuable to me?"