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Ever wonder what it takes to be successful? This chart outlines a simplified correlation between time/effort spent and wealth achieved.

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A clear chart outlining the production possibilities curve in relation to opportunity cost. How much does one have to forgo to achieve more in either category?

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Personally, I am a huge fan of teaching kids while they're young about important economic principles that will affect them in their everyday lives. CashVille Kidz makes use of a common example of going to a concert versus using that same time to instead make money selling a product. Outlining opportunity cost in a friendly way that will engage children and subtly teach them an important lesson in life.

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CashVille Kidz Episode 15: Opportunity Costs

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Trouble grasping the concept? Here are some examples

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Trouble grasping the concept? Here are some examples

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A unique website that gives us a short yet succinct definition of opportunity cost and provides us with an excellent list of real-world, relatable examples  where opportunity cost exists in everyday life and work. Ever wonder if one of your daily decisions involves opportunity cost? Take a look and find out!

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Opportunity cost is the value of something when a particular course of action is chosen. Simply put, the opportunity cost is what you must forgo in order to get something. The benefit or value that was given up can refer to decisions in your personal life, in a company, in the economy, in the environment, or on a governmental level.

Examples of Opportunity Cost

Someone gives up going to see a movie to study for a test in order to get a good grade. The opportunity cost is the cost of the movie and the enjoyment of seeing it.

At the ice cream parlor, you have to choose between rocky road and strawberry. When you choose rocky road, the opportunity cost is the enjoyment of the strawberry.

A player attends baseball training to be a better player instead of taking a vacation. The opportunity cost was the vacation.

Jill decides to take the bus to work instead of driving. It takes her 60 minutes to get there on the bus and driving would have been 40, so her opportunity cost is 20 minutes.

This semester you can only have one elective and you want both basket-weaving and choir. You choose basket weaving and the opportunity cost is the enjoyment and value you would have received from choir.

The opportunity cost of taking a vacation instead of spending the money on a new car is not getting a new car.

When the government spends $15 billion on interest for the national debt, the opportunity cost is the programs the money might have been spent on, like education or healthcare.

If you decide not to go to work, the opportunity cost is the lost wages.

For a farmer choosing to plant corn, the opportunity cost would be any other crop he may have planted, like wheat or sorghum.

Tony buys a pizza and with that same amount of money he could have bought a drink and a hot dog. The opportunity cost is the drink and hot dog.

You decide to spend $80 on some great shoes and do not pay your electric bill. The opportunity cost is having the electricity turned off, having to pay an activation fee and late charges. You might also have food in the fridge that gets ruined and that would add to the total cost.

As a consultant, you get $75 an hour. Instead of working one night, you go to a concert that costs $25 and lasts two hours. The opportunity cost of the concert is $150 for two hours of work.

David decides to quit working and got to school to get further training. The opportunity cost of this decision is the lost wages for a year.

Caroline has $15,000 worth of stock she can sell now for $20,000. She wanted to wait two months because the stock was expected to increase. She decides to sell now. The opportunity cost would be determined in two months and would be the difference between the $20,000 and the price she would have gotten if she sold the stock then.

Jorge really wants to eat at a new restaurant and can only afford it if he does not order a dessert. The opportunity cost is the dessert.

A business owns its building. If the company moves, the building could be rented to someone else. The opportunity cost of staying there is the amount of rent the company would get.

When Tobias graduated high school, he decided to go to college. The opportunity cost of going to college is the wages he gave up working full time for the number of years he was in college.

Mario has a side business in addition to his regular job. If he decides to spend more time on his side business, the opportunity cost is the wages he lost from his regular job.

Mr. Brown makes $400 an hour as an attorney and is considering paying someone $1000 to paint his house. If he decides to do it himself, it will take four hours. His opportunity cost for doing it himself is the lost wages for four hours, or $1600.

With these examples you can see what opportunity cost means and how it can apply in different situations.

Opportunity Cost Examples

By YourDictionary

Opportunity cost is the value of something when a particular course of action is chosen. Simply put, the opportunity cost is what you must forgo in order to get something. The benefit or value that was given up can refer to decisions in your personal life, in a company, in the economy, in the environment, or on a governmental level.

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Opportunity cost is the value of something when a particular course of action is chosen. Simply put, the opportunity cost is what you must forgo in order to get something. The benefit or value that was given up can refer to decisions in your personal life, in a company, in the economy, in the environment, or on a governmental level.

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Comparative Advantage in terms of Opportunity Cost (2:02)

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Comparative Advantage in terms of Opportunity Cost (2:02)

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Another resource from Investopedia discussing an opportunity cost related subject. Similar to our discussions in class about production and international trade, this video depicts the reality of a country's ability to produce a good at a lower opportunity cost to that of a competitor. As a result some countries produce and trade goods that others do not and need to trade for.

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A very reliable source for all information related to economic principles. This resource provides a calculation for determining opportunity cost for those interested in applying it in their own lives. Investopedia actually goes in-depth and defines the difference between a "Sunk cost" and opportunity cost as well as the difference between "Risk" and opportunity cost.

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What Is Opportunity Cost?

Opportunity cost represents the potential benefits that a business, an investor, or an individual consumer misses out on when choosing one alternative over another. While opportunity costs can't be predicted with total certainty, taking them into consideration can lead to better decision making.

Key Takeaways

Formula for Calculating Opportunity Cost

The formula for calculating an opportunity cost is simply the difference between the expected returns of each option. Consider a company that is faced with the following two mutually exclusive options:
Option A: Invest excess capital in the stock market Option B: Invest excess capital back into the business for new equipment to increase production
Assume the expected return on investment (ROI) in the stock market is 10% over the next year, while the company estimates that the equipment update would generate an 8% return over the same period. The opportunity cost of choosing the equipment over the stock market is 2% (10% - 8%). In other words, by investing in the business, the company would forgo the opportunity to earn a higher return-at least for that first year.

Opportunity Cost and Capital Structure

Opportunity cost analysis can play a crucial role in determining a company's capital structure. A business incurs an explicit cost in taking on debt or issuing equity because it must compensate its lenders or shareholders. And each option also carries an opportunity cost.

Money that a company uses to make payments on its bonds or other debt, for example, cannot be invested for other purposes. So the company must decide if an expansion or other growth opportunity made possible by borrowing would generate greater profits than it could make through outside investments.

Companies try to weigh the costs and benefits of borrowing money vs. issuing stock, including both monetary and non-monetary considerations, to arrive at an optimal balance that minimizes opportunity costs. Because opportunity cost is a forward-looking consideration, the actual rate of return (RoR) for both options is unknown at that point, making this evaluation tricky in practice.

Example of an Opportunity Cost Analysis

Assume that a business has $20,000 in available funds and must choose between investing the money in securities, which it expects to return 10% a year, or using it to purchase new machinery. No matter which option the business chooses, the potential profit that it gives up by not investing in the other option is the opportunity cost.

If the business goes with the securities option, its investment would theoretically gain $2,000 in the first year, $2,200 in the second, and $2,420 in the third.

Alternatively, if the business purchases a new machine, it will be able to increase its production. Knowing that the machine setup and employee training will be intensive, and the new machine will not be up to maximum efficiency for the first couple of years, the company estimates that it would net an additional $500 in profit in the first year, then $2,000 in year two, and $5,000 in all future years.

By these calculations, choosing the securities makes sense in the first and second years. However, by the third year, an analysis of the opportunity cost indicates that the new machine is the better option ($500 + $2,000 + $5,000 - $2,000 - $2,200 - $2,420) = $880.

The Most Expensive Pizza Ever?

Opportunity Cost vs. Sunk Cost

A sunk cost is money already spent at some point in the past, while opportunity cost is the potential returns not earned in the future on an investment because the money was invested elsewhere. When considering opportunity cost, any sunk costs previously incurred are typically ignored.

Buying 1,000 shares of company A at $10 a share, for instance, represents a sunk cost of $10,000. This is the amount of money paid out to invest, and it can't be recouped without selling the stock (and perhaps not in full even then).

From an accounting perspective, a sunk cost also could refer to the initial outlay to purchase an expensive piece of heavy equipment, which might be amortized over time, but which is sunk in the sense that the company won't be getting the money back.

Opportunity Cost vs. Risk

In economics, risk describes the possibility that an investment's actual and projected returns will be different and that the investor may lose some or all of their capital. Opportunity cost reflects the possibility that the returns of a chosen investment will be lower than the returns of a forgone investment.

The key difference is that risk compares the actual performance of an investment against the projected performance of the same investment, while opportunity cost compares the projected performance of an investment against the projected performance of another investment.

Accounting Profit vs. Economic Profit

Accounting profit is the net income calculation often stipulated by the generally accepted accounting principles (GAAP) used by most companies in the U.S. Under those rules, only explicit, real costs are subtracted from total revenue.

Economic profit, however, includes opportunity cost as an expense. This theoretical calculation can then be used to compare the actual profit of the company to what its profit might have been had it made different decisions.

Economic profit (and any other calculation that considers opportunity cost) is strictly an internal value used for strategic decision making.

What Is a Simple Definition of Opportunity Cost?

Opportunity cost refers to the hidden cost associated with not taking an alternative course of action.

What Is an Example of Opportunity Cost in Investing?

Consider a young investor who decides to put $5,000 into bonds each year and dutifully does so for 50 years. Assuming an average annual return of 2.5%, their portfolio at the end of that time would be worth nearly $500,000. Although this result might seem impressive, it is less so when you consider the investor's opportunity cost. If, for example, they had instead invested half of their money in the stock market and received an average blended return of 5% a year, their portfolio would have been worth more than $1 million. Their opportunity cost in this case would be over $500,000.

How Do You Predict Opportunity Cost?

Any effort to predict opportunity cost must rely heavily on estimates and assumptions. There's no way of knowing exactly how a different course of action will play out financially over time. Investors might use the historic returns on various types of investments in an attempt to forecast their likely returns. However, as the famous disclaimer goes, "Past performance is no guarantee of future results."

The Bottom Line

While opportunity costs can't be predicted with absolute certainty, they provide a way for companies and individuals to think through their investment options and, ideally, arrive at better decisions.

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Opportunity Cost: Definition, Calculation Formula, and Examples

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Opportunity cost is the potential forgone profit from a missed opportunity-the result of choosing one alternative over another.

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Opportunity cost is everywhere in our lives. Simple tasks such as studying or watching television have factors of opportunity cost relating to them.

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Small Business Perspective of Opportunity Cost

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Small Business Perspective of Opportunity Cost

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Opportunity cost as explained for small business owners. This website includes a definition of opportunity cost, it explains why opportunity cost matters in relation to business matters and goes over opportunity cost as a trade-off. An investors perspective is also considered based on the ease of an investment and the liquidity of investments relating to opportunity cost.

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Investors are always faced with options about where they should invest their money.

Opportunity cost is the cost of a foregone alternative. If you chose one alternative over another, then the cost of choosing that alternative is an opportunity cost.

The term opportunity cost is often used in finance and economics when trying to choose one investment, either financial or capital, over another. It is a measure of any economic choice as compared to the next best one.

For example, there is an opportunity cost over choosing an investment in bonds over an investment in stocks.

Why Opportunity Costs Matter

Opportunity costs are a factor not only in decisions made by consumers, but in other decisions as well such as production, time management and capital allocation.

Alternative Financial Actions

When referring to opportunity costs, investors often see it as the benefits you would have received by taking an alternative financial action.

The difference in return between a chosen investment and one that is the forgone alternative is essentially your opportunity cost. For example, if you invest in a stock and it returns only 3% over the year, and you gave up the opportunity of another investment yielding 8%, your opportunity costs are 8% - 3%, which is 5%.

For example, there is an opportunity cost over choosing an investment in bonds over an investment in stocks.

Opportunity Cost Viewed as a Trade-Off

Some investors view opportunity costs as a trade-off.

So if you chose to invest in government bonds over high-risk stocks, that's a trade-off on return that you chose.

Trade-offs are when you forgo one options for another. There are trade-offs involved in any decision that requires choosing one option or another. For example, if you chose not to go to one restaurant in order to eat at another, that is a trade-off.

You chose to read this article instead of reading another, checking your Facebook page or watching television. You made a choice that resulted in a trade-off. Your life is the result of your past decisions. That, essentially, is the definition of opportunity cost.

What is Liquidity of Opportunity Cost?

If two investments have the potential to generate the same return, but one requires you to tie up your cash for two years, while another won't allow you to touch your money for 10 years, you need to make a decision based on how liquid you need your money to be.

One option may be more attractive based on the predicted rate of return, but the other option may be more appealing based on the need for your money to be liquid.

The biggest opportunity cost when it comes to liquidity has to do with the chance that you might pass up a "hot" investment because you can't get your hands on your money that is tied up in another investment.

Related Articles:

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Investors are always faced with options about where they should invest their money. Opportunity cost is the cost of a foregone alternative. If you chose one alternative over another, then the cost of choosing that alternative is an opportunity cost.

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Khan Academy - Opportunity Cost made easy (5:48)

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Khan Academy - Opportunity Cost made easy (5:48)

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A video made by Khan Academy quickly going over opportunity cost.  A brief yet satisfying introduction to  opportunity cost that makes use of easily understood examples of rabbits and berries in an effort to teach anyone the basics. I have always enjoyed Khan Academy's videos as they have experience in connecting with those who are trying to learn and can be considered as a credible resource for information

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Opportunity cost and marginal cost based on the PPC