Learning Outcomes
- Understand opportunity costs
The opportunity cost of a decision is the benefit that you would have gained if you’d made a different choice. For instance, if you are self-employed and bill $200 per hour and usually work 8 hours, but you decide to take a day off, the opportunity cost of your day off is $1,600. There are intangible and non-quantifiable factors at play in that example. For instance, if you work every day you might face burn-out and actually make less money in the long-term.
Let’s say you value your free time at $200 per hour and someone offers you a 10-hour job for $2,500. The opportunity cost of taking that job is losing your free time. The opportunity cost of not taking the job because you choose to spend time with your family is $2,500.
Let’s look at our B&B example:
| Guest Room | Gift Shop | |
|---|---|---|
| Revenues | $ 32,850 | $ 48,000 |
| Subcategory, Costs | ||
| Housekeeping | $ 10,950 | |
| Cost of goods sold | $ 19,200 | |
| Operating Income | Single Line$ 21,900Double line | Single Line$ 28,800Double line |
What is the opportunity cost of the owner waiting to make a decision? Every month, the B&B is forgoing $2,400 in profit from the gift shop. Assume the owner didn’t do this analysis and simply chose to turn the space into another guest room, or decided that the idea of a gift shop did not fit with the overall ambiance of the B&B. The opportunity cost of choosing the guest room option over the gift shop option is $6,900 annually.
Let’s take this one step further. Say the owner could have invested the $65,000 remodeling costs for the gift shop in The Home Depot stock when it was trading at 152.20 on March 20, 2020, but instead chose to invest it in her own business. On March 19, 2021, when The Home Depot stock was trading at 289.10, her 427 shares would have been worth $123,466, an increase of $58,465. That makes the opportunity cost of remodeling the room almost $30,000 since she could have made $58,465 instead of $28,800. Of course, at the time, she had no way of knowing that The Home Depot stock would rise so high so fast, and no assurance that it would continue to do so or not drop dramatically in the near future.
Still, every decision has options, and the benefits foregone by the options not chosen are the costs of the opportunity presented. Therefore, in short and long-term decision-making, it is important to identify as many options as possible.
For a quick review of an opportunity cost, watch:
You can view the transcript for “Opportunity Cost” here (opens in new window).
Now, check your understanding of the concept of opportunity cost.
