Up to this point when we calculated the cost of studying economics we have only the cost to you or your family. Economists, however, are not only interested in the opportunity cost to the individual, but also the opportunity cost to society. The question then is how much does it cost society to provide a student with the opportunity to study economics. To calculate this cost, we need to include the subsidy that government pays towards higher education.
For a hypothetical student, the calculation of the opportunity cost to society might be as follows:
| Course fee: | R2 000 |
| Internet connectivity: | R300 |
| Hardware and software cost: | R1 000 |
| Subsidy by government: | R2 400 |
| Travel cost to examination centre: | R120 |
| Wages the student could have earned if not studying economics: | R8 000 |
According to these figures, the opportunity cost to provide a student with an opportunity to study economics is R13 829, which is significantly more than the direct monetary cost to the student.
The reason forgone (forgo: to do without) wages are included is because society is losing the contribution to production that the student could have made if he or she were not studying. It is a loss to society and therefore part of the cost.
It is not only individuals and households that face opportunity cost, but businesses and governments as well.
Businesses make a variety of decisions on a daily basis and each of these decisions implies an opportunity cost. If a business, for instance, decides to use its personnel to upgrade its customer database, the opportunity cost might be not using the personnel to update the sales database. Opening a new factory might also involve an opportunity cost in terms of not investing in equipment to improve the efficiency of the existing factory.
The South African government also faces opportunity costs. It strives to provide housing, electricity, running water, free health services, education and jobs to South Africans. However, because resources are limited, it will have to decide what must be done first and what will have to be postponed until later. The best alternative that is not undertaken is then the opportunity cost of the current choice. If the government decides to provide free higher education and the best alternative for the use of this money is the creation of jobs, then the opportunity cost of free higher education is the jobs that are not created.
As you can see from the above, the concept of opportunity cost may be applied to many different situations and arises when we need to make a choice between different alternatives. While opportunity cost is usually expressed in terms of money – as was done in the example of the student studying economics – it can also be done in term of hours spent or some kind of output measure.
Consider the following example:
In the following hypothetical country, laptops and mobile phones are produced using the country’s resources. If all the resources are used, the country can produce the following combination of laptops and mobile phones:
Production of laptop and mobile phones
| Combinations | Laptops | Mobile phones |
|---|---|---|
| A | 3 000 | 18 000 |
| B | 4 000 | 10 000 |
The information in the above table shows that the opportunity cost of increasing the production of laptops from 3 000 to 4 000, that is, by 1 000, is the loss of the production of mobile phones from 18 000 to 10 000. The opportunity cost of increasing the production of laptops by 1 000 is therefore 8 000 mobile phones.
Activity
Now do the following activities on opportunity cost:
A small business owns the building in which it operates and therefore pays no rent. This then implies that there is no opportunity cost for the business with regard to the building.
Think again. The statement is false.
The best alternative use of the building is the opportunity cost of the small business using the building for their own operation. For instance, the owners of the business could have rented out the building and rented more suitable premises elsewhere. When economists calculate the cost of doing business, they include this alternative use as part of the cost.
Correct. The statement is indeed false.
The best alternative use of the building is the opportunity cost of the small business using the building for their own operation. For instance, the owners of the business could have rented out the building and rented more suitable premises elsewhere. When economists calculate the cost of doing business, they include this alternative use as part of the cost.
Johannes is currently working as a computer programmer for a large corporation and earns R500 000 per year. He is considering starting his own business and is currently estimating the opportunity cost of doing so. Should he include the loss of his current income as part of the opportunity cost to start his own business?
Correct. He should include it.
Opportunity cost is the value to the decision maker of the best alternative that is given up or sacrificed. Johannes is giving up his salary of R500 000 per year, and it should therefore be part of his opportunity cost.
Think again. He should include it.
Opportunity cost is the value to the decision maker of the best alternative that is given up or sacrificed. Johannes is giving up his salary of R500 000 per year, and it should therefore be part of his opportunity cost.