Lesson: How Individuals Make Choices Based on Their Budget Constraint

The Concept of Opportunity Cost

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  • Opportunity cost means making a decision between what a person would have to give up in order to have something else.
  • Every choice we make has an opportunity cost.
  • The opportunity cost is based on the value of the best choice. People decide what will be done with their money, time, and other resources before choosing an activity.

Economists use the term opportunity cost to indicate what one must give up obtaining what he or she desires. The idea behind opportunity cost is that the cost of one item is the lost opportunity to do or consume something else. In short, opportunity cost is the value of the next best alternative. For Alphonso, the opportunity cost of a burger is the four bus tickets he would have to give up. He would decide whether or not to choose the burger depending on whether the value of the burger exceeds the value of the forgone alternative—in this case, bus tickets. Since people must choose, they inevitably face trade-offs in which they have to give up things they desire to obtain other things they desire more.

A fundamental principle of economics is that every choice has an opportunity cost. If you sleep through your economics class, the opportunity cost is the learning you miss from not attending class. If you spend your income on video games, you cannot spend it on movies. In short, opportunity cost is all around us and part of human existence.