Applying Opportunity Cost

Idea

Opportunity cost is explained, in an answer, by naming three things:

1. the scarce resource being allocated;

2. the next best alternative use of that resource; and

3. the value of that alternative — which is the opportunity cost.

Stating all three is what turns a vague mention of “cost” into a mark-bearing point, because the value of the alternative only has meaning relative to the agent’s goal.

Context

The same structure applies across all three agents:

• Consumer. A buyer with a limited budget who chooses the latest iPhone forgoes the utility of the next best alternative — say a Samsung Galaxy. The resource is the budget; the value forgone is that alternative’s utility.

• Producer. A farmer with limited land who plants rice forgoes the profit of the next best crop — say sugarcane. The resource is the land; the value forgone is that crop’s profit.

• Government. Singapore’s spending of $225 million on the Punggol Waterway forgoes the next best public use of those funds — hospitals, schools or transport infrastructure. The resource is the $225 million; the value forgone is the social welfare the alternative would have produced.