Suppose that, after graduating from college, you have two options: to go to school for an additional year to get an advanced degree or to take a job immediately. You would like to enroll in the extra year in school but are concerned about the cost.

What exactly is the cost of that additional year of school? Here is where it is important to remember the concept of opportunity cost: the cost of the year spent getting an advanced degree includes what you forgo by not taking a job for that year. The opportunity cost of an additional year of school, like any cost, can be broken into two parts: the explicit cost of the year’s schooling and the implicit cost.

An explicit cost is a cost that requires an outlay of money. For example, the explicit cost of the additional year of schooling includes tuition. An implicit cost, though, does not involve an outlay of money. Instead, it is measured by the value, in dollar terms, of the benefits that are forgone. For example, the implicit cost of the year spent in school includes the income you would have earned if you had taken a job instead.

A common mistake, both in economic analysis and in life—whether individual or business—is to ignore implicit costs and focus exclusively on explicit costs. But often the implicit cost of an activity is quite substantial—indeed, sometimes it is much larger than the explicit cost.

Table 9-1 gives a breakdown of hypothetical explicit and implicit costs associated with spending an additional year in school instead of taking a job. The explicit cost consists of tuition, books, supplies, and a computer for doing assignments—all of which require you to spend money. The implicit cost is the salary you would have earned if you had taken a job instead. As you can see, the total opportunity cost of attending an additional year of schooling is $44,500, the sum of the total implicit cost—$35,000 in forgone salary, and the total explicit cost—$9,500 in outlays on tuition, supplies, and computer. Because the implicit cost is more than three times as much as the explicit cost, ignoring the implicit cost would lead to a seriously misguided decision. This example illustrates a general principle: the opportunity cost of any activity is equal to its explicit cost plus its implicit cost.

A slightly different way of looking at the implicit cost in this example can deepen our understanding of opportunity cost. The forgone salary is the cost of using your own resources—your time—in going to school rather than working. The use of your time for more schooling, despite the fact that you don’t have to spend any money on it, is still costly to you. This illustrates an important aspect of opportunity cost: in considering the cost of an activity, you should include the cost of using any of your own resources for that activity. You can calculate the cost of using your own resources by determining what they would have earned in their next best use.

Understanding the role of opportunity costs makes clear the reason for the surge in school applications in 2010: a rotten job market. Starting in 2009, the U.S. job market deteriorated sharply as the economy entered a severe recession. By 2010, the job market was still quite weak; although job openings had begun to reappear, a relatively high proportion of those openings were for jobs with low wages and no benefits. As a result, the opportunity cost of another year of schooling had declined significantly, making spending another year at school a much more attractive choice than when the job market was strong.