Principle #2: The True Cost of Something Is Its Opportunity Cost

It is the last term before you graduate, and your class schedule allows you to take only one elective. There are two, however, that you would really like to take: Intro to Computer Graphics and History of Jazz.

The real cost of an item is its opportunity cost: what you must give up in order to get it.

Suppose you decide to take the History of Jazz course. What’s the cost of that decision? It is the fact that you can’t take the computer graphics class, your next best alternative choice. Economists call that kind of cost—what you must give up in order to get an item you want—the opportunity cost of that item. This leads us to our second principle of individual choice:

The opportunity cost of an item—what you must give up in order to get it—is its true cost.

Mark Zuckerberg understood the concept of opportunity cost.
AP Photo/Jeff Chiu

So the opportunity cost of taking the History of Jazz class is the benefit you would have derived from the Intro to Computer Graphics class.

The concept of opportunity cost is crucial to understanding individual choice because, in the end, all costs are opportunity costs. That’s because every choice you make means forgoing some other alternative.

Sometimes critics claim that economists are concerned only with costs and benefits that can be measured in dollars and cents. But that is not true. Much economic analysis involves cases like our elective course example, where it costs no extra tuition to take one elective course—that is, there is no direct monetary cost. Nonetheless, the elective you choose has an opportunity cost—the other desirable elective course that you must forgo because your limited time permits taking only one. More specifically, the opportunity cost of a choice is what you forgo by not choosing your next best alternative.

You might think that opportunity cost is an add-on—that is, something additional to the monetary cost of an item. Suppose that an elective class costs additional tuition of $750; now there is a monetary cost to taking History of Jazz. Is the opportunity cost of taking that course something separate from that monetary cost?

Well, consider two cases. First, suppose that taking Intro to Computer Graphics also costs $750. In this case, you would have to spend that $750 no matter which class you take. So what you give up to take the History of Jazz class is still the computer graphics class, period—you would have to spend that $750 either way. But suppose there isn’t any fee for the computer graphics class. In that case, what you give up to take the jazz class is the benefit from the computer graphics class plus the benefit you could have gained from spending the $750 on other things.

Either way, the real cost of taking your preferred class is what you must give up to get it. As you expand the set of decisions that underlie each choice—whether to take an elective or not, whether to finish this term or not, whether to drop out or not—you’ll realize that all costs are ultimately opportunity costs.

Sometimes the money you have to pay for something is a good indication of its opportunity cost. But many times it is not.

One very important example of how poorly monetary cost can indicate opportunity cost is the cost of attending college. Tuition and housing are major monetary expenses for most students; but even if these things were free, attending college would still be an expensive proposition because most college students, if they were not in college, would have a job. That is, by going to college, students forgo the income they could have earned if they had worked instead. This means that the opportunity cost of attending college is what you pay for tuition and housing plus the forgone income you would have earned in a job.

It’s easy to see that the opportunity cost of going to college is especially high for people who could be earning a lot during what would otherwise have been their college years. That is why star athletes like LeBron James and entrepreneurs like Mark Zuckerberg, founder of Facebook, often skip or drop out of college.