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What is an Opportunity Cost?

Definition: An opportunity cost is the economic concept of potential benefits that a company gives up by taking an alternative action. In other words, this is the potential benefit you could have received if you had taken action A instead of action B.

What Does Opportunity Cost Mean?

What is the definition of opportunity cost? Each business transaction and strategy has benefits related to it, but businesses must choose a specific action. By choosing one alternative, companies lose out on the benefits of the other alternatives. In other words, opportunity costs are not physical costs at all. They are theoretical costs or missed opportunities.

Let's take a look at an example.

Example

Managers have to evaluate alternative costs in almost every major strategy business decision. For instance, assume a manufacturer needs to increase production and has to decide whether to expand its manufacturing plant or hire a third shift of workers. The benefit of expanding the plant would be that the company would have extra capacity and the ability to hire a third shift in the future. The benefit of hiring a third shift now is that the company would save the building costs and risk of expanding the plant.

As you can see, both of these alternatives have mutually exclusive benefits. The management has to choose one of these alternatives. After much debate, the management decides to save costs and hire a third shift of workers. The alternative cost of management hiring a third shift is the inability to increase capacity. This might also lead to lost projects in the future because the business can't produce them in time.

Opportunity costs can be viewed as the price on inaction. In other words, by a company not taking an alternative action, they are missing out on opportunities or incurring alternative costs. It can also be viewed as the pros and cons list of alternative actions.

Summary Definition

Define Opportunity Costs: Opportunity cost means the foregone benefits that you could have earned had you chosen to a different course of action.

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