- noun the cost of a business initiative in terms of profits that could have been gained through an alternative plan
- noun the value of another method of investment which could have been used, instead of the one adopted
- noun the cost of a scarce factor of production used to produce a good or service, as opposed to another which could have been used instead of the one adopted.
- (written as Opportunity Cost)
Economists use the word 'cost' in a particular way that differs from everyday usage and also from accounting concepts of cost. Cost, in economics, is opportunity cost. Opportunity cost is the value of a resource in its most highly valued alternative use. In a world of competitive markets, in which all goods are traded and where there are no market imperfections, opportunity cost is revealed by the prices of resources: the alternative uses forgone cannot be valued higher than these prices or the resources would have gone to such uses. Where these stringent conditions are not met, opportunity cost and market prices can diverge and shadow prices may be estimated to measure the former.
Identification of opportunity cost is a skilled art that can be applied only in the context of a particular decision. It requires one either to identify the consequences of alternative courses of action or to assume that someone else has done so. In general, opportunity cost cannot be defined independently of the context in which the term is being used. There are, perhaps, two main reasons for this. First, if the context is, as it frequently is, one of decision-making, then the cost of a decision will depend upon such factors as the period of time over which the decision is believed to have consequences, which may go either well beyond a conventional accounting period (for example, when one decides to add a particular drug to a reimbursement tariff for the indefinite future) or fall short of it (for example, as when one wishes to know the cost of acquiring - as distinct from owning and operating - an item of equipment). Second, one must ask 'cost to whom?', for example, whether the resource-using con sequences of a decision are to be seen as limited to the decision-maker alone, or to a wider set of affected parties.
At best, market prices can reveal the opportunity cost of resources in their most highly valued uses to people other than the decision-taker in question. They do this by showing what the decision-maker must pay to bid resources away from others. The opportunity cost of using resources one already owns is not usually revealed in market prices since the best alternative may be an alternative use in one's own organization (unless there is an internal market). In such cases, opportunity costs need to be elicited by discussion and judgment, and may not be readily put in monetary terms.
In some health care applications, opportunity cost is health forgone - as, for example, when there is a fixed budget that can be used only for the promotion of health. In such circumstances, the opportunity cost of using resources one way rather than another is the health gain not secured through the other route.
Opportunity costs should not be confused with transfer payments or effort.