IGCSEEconomicsCambridge (CIE)Revision Notes1. The Basic Economic Problem1.3 Opportunity CostOpportunity Cost in Decision Making

Opportunity Cost in Decision Making (Cambridge (CIE) IGCSE Economics)

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Steve Vorster

Definition of Opportunity Cost

  • Opportunity cost is the loss of the next best alternative when making a decision

  • Due to the problem of scarcity, choices have to be made about how to best allocate limited resources amongst competing wants and needs

  • There is an opportunity cost in the allocation of resources

    • When a consumer chooses to purchase a new phone, they may be unable to purchase new jeans. The jeans represent the loss of the next best alternative (the opportunity cost)

    • When a producer decides to allocate all of their resources to producing electric vehicles, they may be unable to produce petrol vehicles. The petrol vehicles represent the loss of the next best alternative (the opportunity cost)

    • When a government decides to provide free school meals to all primary students in the country, they may be unable to fund some rural libraries, which may have to close. The libraries represent the loss of the next best alternative (the opportunity cost)

The Influence of Opportunity Cost on Decision Making

  • An understanding of opportunity cost may change many decisions made by consumers, workers, firms and governments

  • Factoring the opportunity cost into a decision often results in different outcomes and a different allocation of resources

Examples of how the Consideration of Opportunity Costs can Change Decisions

Stakeholder

Example

Consumer

  • Ashika is wanting to visit her best friend in Iceland

  • She looks at flight prices from London to Reykjavík

  • On Friday night it costs £120 whereas Thursday night is only £50

  • She is about to book the Thursday flight but then realises that the opportunity cost of saving £60 on a flight is the inability to work on Friday (loss of £130 income)

  • Ashika books the more expensive flight. If she had booked the cheaper flight, it would have cost her the income from the missed day of work (£130) + £50 for the ticket 

Worker

  • Ric has been offered two jobs and is deciding which one to accept

  • Job A offers £400 a month more in salary than Job B, but Job B offers the flexibility of working from home

  • Most people would only consider the actual cost of commuting before they make a decision, which in Ric's case is £40 a week or £160 a month

  • Ric values his free time and decides that each hour he can save in commuting is worth £20 to him (£180 a week) - he is considering the opportunity cost of commuting

  • Ric decides to take Job B as the cost of monthly travel (4 x £40) and value of the lost hours spent commuting (4 x £180) adds up to £880 a month

Firm

  • A firm selling organic avocados is offered a supply contract by a large supermarket that wants to buy all of their stock each month, but at a low price

  • The supermarket is a prestigious customer

  • The firm decides not to accept the contract as the opportunity cost (loss of prestigious customer) is worth less than the lost revenue to existing customers

Government

  • The Australian Government has entered into a contract with France to supply them with 8 submarines valued at $70 billion

  • The USA hears about it and pressurises Australia to buy the submarines from them instead

  • The Australian Government considers the opportunity cost of denying the USA, which includes less preferential deals on other military hardware and general trade agreements

  • They decide to break the contract with France and view this as the approach that carries the lowest opportunity cost

Examiner Tip

Opportunity cost is about the loss of the next best alternative. It is not a monetary amount. MCQ will frequently include a monetary amount as one of the options and it is never the answer! Always look at the options presented and identify the next best alternative

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    Steve Vorster

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