How to Calculate the Opportunity Cost in Economics
Economists are used to calculating the effects of decisions. For example, economists are consulted before most big government policies are implemented, like raising taxes, funding a program or slashing a budget. However, assessing the direct costs of implementing a program is only one part of the equation. Economists also consider what is referred to as the “opportunity cost.” Economist.com defines this term as what is given up in pursuit of something else. How to calculate the opportunity cost is a straightforward process.
At the top of the paper, write the action for which you are finding the opportunity cost. For example, an economics question that states, “Find the opportunity cost of moving to Manhattan,” the action in question is moving to Manhattan.
Write the immediate opportunity costs of pursuing the action. Moving to Manhattan may cost $300 in moving fees and ample time.
Assess what options are foreclosed as a result of following the selected course of action. Write each alternative in bullet points down the paper. Leave space to write between each alternative. Continuing with the example of calculating the opportunity cost of moving to Manhattan, other alternatives you forego could be cheaper living expenses, a safer neighborhood and your well-known social circle.
List the benefits of the alternative choices. Under the bullet points, elaborate each option’s benefits. Weigh each benefit against the main choice when writing out the points. Thus, the point of cheaper living expenses is listed as what you would pay in New York subtracted from your current living costs: written out, it may show “$70 savings for electricity, $260 saved by paying less rent and $300 not spent on higher-priced meals and entertainment for a total of $630.”
Write the calculated opportunity cost of the action at the bottom of the page using the immediate costs and alternatives in bullet points. From the example above, “the opportunity cost of moving to Manhattan is $300 in moving fees, time, $670 in increased living expenses, leaving a safer and quieter neighborhood, and a closer relationship with my friends."
- Do not double-count. If asked to find just the highest monetary opportunity cost, choose the alternative scenario with the highest cost. For example, if you are calculating the opportunity cost of opening a bakery and you find opening a restaurant is foregoing $2,000 in profit and opening a bar is foregoing $3,000, list the bar's profit as the monetary opportunity cost. Because you cannot pursue both alternatives at the same time, the answer is the higher of the two choices ($3,000), not the total of the two ($5,000).
- Tips: Do not write costs strictly in terms of dollars and cents. An opportunity cost is not always a numbers-based answer. Though an opportunity cost may be monetary, a cost can also be leisure, time and anything else of value. Choose alternatives that are mutually exclusive to the main course of action, or, alternatives you know cannot be achieved at the same time. For instance, do not list "working part-time" as an opportunity cost of pursuing a degree if you are capable of doing both.