Opportunity Cost

Financial Dictionary -> Investing -> Opportunity Cost

Opportunity Cost, which is sometimes known as economic opportunity loss is an economist's approach to costs, whereby the cost of a decision is measured against the likely decision's alternative. It is a way of working out the cost of missing out on the next best alternative.

Working out what financial costs and time costs of one route compared to another helps decide which is the most efficient; this however is not always accurate, as it is often based on estimates. Other factors are used within opportunity cost, not just financial. These might include the pleasure of making one decision against the other (the job is more fun), business ethics (it may make sense financially but dumping waste might give the company a bad public image) and various other social factors.

Opportunity cost is not written on any financial statements or accounts, like for example depreciation.
Every business choice has an opportunity cost, so therefore all the alternatives should be considered before making a crucial business decision. Consumers themselves also make the most out of their disposable income by looking for cheaper alternatives. (Although the cost may be in quality).

An example of opportunity cost at play in a business could be:
A company makes the decision to keep on several employees instead of using new robot hardware because they value their work and want to keep worker morale high, which in turn leads to enthusiasm and better output. The opportunity cost is in the potential to save money by laying off those workers and not having to pay those wages.

An example of opportunity cost from an individual's viewpoint:
David has $20,000 to invest in the stock market, but opts instead to put it in an online savings account because he is not well educated on buying shares. The opportunity cost is the potential of making more money from buying shares than regular bank interest.
Although it can be treated in an overt manner, the theory of opportunity cost goes on ever day without giving it a second thought. It is simply weighing up decisions.