Decoding Opportunity Cost
The term ‘opportunity cost’ is frequently used in the business dailies. For the reason it’s an important term, understanding its exact meaning is very important.
What is ‘opportunity cost?’
The term refers to a cost of an alternative that must be relinquished so as to purse a definite action.
To call it differently, these are the benefits that one could have received after taking an alternative action.
Let’s understand the concept using an example.
Just imagine it using an example of a person who places a sizable chunk of his savings in certain stocks that give 2 per cent returns. By investing in shares he misses the opportunity at the same time to invest in other risk-free financial instruments such as government bonds which can give around 6 per cent.
Opportunity cost in such a case is 6% – 2% = 4%
Here is another example. A young boy gives up a job offer and an opportunity to earn money so as to study further. However, doing this he completes his education which can help him getting a highly remunerative job that can offset the loss of wages in the year he was studying.
In both examples, a choice between two options must be made. It would be an easy decision if you knew the end result; but, the risk that you could accomplish greater ‘benefits’ (be the monetary or else) with another alternative is the ‘opportunity cost.’