Opportunity Costs

Life is full of choices. Because resources are scarce, we must always consider how to spend our limited incomes or time. When you decide whether to study economics, buy a car, or go to college, in each case you must consider how much the decision will cost in terms of forgone opportunities. The cost of the forgone alternative is the opportunity cost of the decision.

The concept of opportunity cost can be illustrated using the PPF. Examine the frontier in Figure 1-2, which shows the trade-off between guns and butter. Suppose the country decides to increase its gun purchases from 9000 guns at D to 12,000 units at C. What is the opportunity cost of this decision? You might calculate the cost in dollar terms. But in economics we always need to "pierce the veil" of money to examine the real impacts of alternative decisions. On the most fundamental level, the opportunity cost of moving from D to C is the butter that must be given up to produce the extra guns. In this example, the opportunity cost of the 3000 extra guns is 1 million pounds of butter forgone.

Or consider the real-world example of the cost of opening a gold mine near Yellowstone National Park. The developer argues that the mine will have but a small cost because Yellowstone's revenues will hardly be affected. But an economist would answer that the dollar receipts are too narrow a measure of cost. We should ask whether the unique and precious qualities of Yellowstone might be degraded if a gold mine were to operate, with the accompanying noise, water and air pollution, and degradation of amenity value for visitors. While the dollar cost might be small, the opportunity cost in lost wilderness values might be large indeed.

In a world of scarcity, choosing one thing means giving up something else. The opportunity cost of a decision is the value of the good or service forgone.

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