Trade-Offs and Opportunity Cost

Whenever you use a factor of production, a cost is going to be incurred. Why? The factors of production are limited, not limitless. As a result, whenever you choose to use land, labor, capital, or entrepreneurship for one purpose, you lose the ability to use it for another. Take a resource like labor — your labor. Say that you can spend an hour writing a book, teaching a class, or weaving a hammock. The choices you face are called trade-offs. Assume you choose to weave a hammock. You can neither teach a class nor write a book in that hour of time. If writing a book is your next best alternative, then economists would say that the opportunity cost of spending an hour weaving a hammock is the hour you could have spent writing a book. Opportunity cost is the next best alternative use of a resource.

Opportunity cost is sometimes referred to as implicit cost. For any productive activity there are explicit costs like labor, raw materials, and overhead, which are easily calculated, and there are the implicit costs, which are more difficult to assess.

For example, suppose it's a beautiful Friday morning and you think to yourself, “I could go to work like I'm supposed to, I could stay home and sleep away the day, or I could fly to Cozumel and hang out on the beach and do some scuba diving.” Assume that you choose to take the trip to Cozumel, but going to work was your next best alternative. What was the cost of your trip? You paid for the taxi to the airport, the plane ticket, an all-inclusive hotel package, and a dive on Palancar Reef. Was that your only cost? No. You also sacrificed the money you could have made working. Opportunity cost is a bummer. Make sure to always count it when making a decision.

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