Scarcity & Opportunity Cost

What is scarcity? Scarcity is the fundamental economic problem of having seemingly unlimited human wants in a world of limited resources

Define the term opportunity cost “When asked how much something costs, people usually answer by giving its price, or money cost.  Economists usually measure cost differently, using what they call opportunity cost, defined as the value of the next best alternative opportunity that is given up in order to do something.”

In simpler terms: The cost of passing up the next best choice when making a decision.

Examples: Resources are scarce. Our desires are not. This means that we must make choices. When we choose to watch TV rather than do our homework, we lose the benefits that doing our homework would have brought.

Examples: If you have $10, there are many things you could do with that money. All of the options (or alternatives) that you don’t choose are forfeited. But it is the cost of the next best alternative (your second choice) that is used when calculating opportunity costs.

The need to identify opportunity cost To choose something is to not choose something else. Making a good decision takes into consideration what is lost when the decision is made. Every time a decision is made, because we have limited resources, there is a foregone alternative. Opportunity cost is actually the value of the next-highest-valued alternative use of that resource.

Discuss factors that influence the inclusion of opportunity costs in business decision-making. Experience—do you know all of the alternatives that exist? For example, a 2nd grader learning to play football may not realize that an opportunity cost of kicking a field goal for three points is the chance of making a touchdown for six (or seven) points.

Discuss factors that influence the inclusion of opportunity costs in business decision-making. Vagueness of information—is it possible to calculate the value of the next best alternative?

Discuss factors that influence the inclusion of opportunity costs in business decision-making. Thoughtfulness—Has the situation been explored thoroughly enough to see the decision in light of other alternatives? An example of looking at the same question in 3 different ways: "If we build a dam, we'll have better flood control and cheaper electricity. If we don't, then we'll experience occasional flooding, and electricity will be more expensive." "If we build the dam, it will provide us with flood control and cheaper electricity, but it will cost us $100 million." "If we build the dam, we'll have flood control and cheaper electricity. But the $100 million to build the dam could be used instead to build two new high schools."

Describe problems with being able to identify opportunity costs. It is difficult to place a value on some opportunity costs, such as time, experience gained, etc. For example, part of the opportunity cost of deciding not to go to college is foregoing knowledge about the world, developing lifelong friendships, exploring career options, and learning about one’s self.

Explain the relationships between opportunity costs and trade-offs. Trade-off: an exchange for one thing in return for another Opportunity cost: the value of the next-highest-valued alternative Example of trade-off: watching TV instead of doing your homework Example of opportunity cost: received enjoyment from watching TV, but sacrificed the points you would have received from your homework, the knowledge doing your homework would have created, the feeling of accomplishment that having completed your assignment would have created.

Why/when are opportunity costs included in a business decision? “Because of its usefulness as an analytic tool. In a market economy, people seek to make a profit. To do that, they must utilize their resources as efficiently as they can, in order to bring back the greatest benefit to themselves. Many, many factors must be weighed. In making all those decisions, it is a great help to know the value of the next-best thing that one could have chosen.”

Identify the opportunity costs associated with situations involving economic decision-making. When considering a choice, ask yourself three questions: What alternative opportunities are there? Which is the best of these alternative opportunities? What would I gain if I selected my best alternative opportunity instead of the choice I'm considering?” (this is the opportunity cost)