Opportunity costs are the financial or non-financial benefits that you give up by choosing one option over another. Whether personal or for business, an opportunity cost exists because you choose one option over another believing that option has better benefits compared to the option you do not choose. Giving consideration to opportunity costs is important as it helps you carefully compare your options when resources are limited.
Advantage 1: Awareness of Lost Opportunity
A main benefit of opportunity costs is that it causes you to consider the reality that when selecting among options, you give up something in the option not selected. If you go to a grocery store looking for meat and cheese, but only have enough money for one, you have to consider the opportunity cost of the item you decide not to buy. Recognizing this helps you make more informed and economically sensible decisions that maximize your resources.
Advantage 2: Relative Price
Another important benefit of considering your opportunity cost is it allows you to compare relative prices and the benefits of each alternative. Compare the total value of each option and decide which one offers the best value for your money. For instance, a business with an equipment budget of $100,000 may buy 10 pieces of Equipment A at $10,000 or 20 pieces of Equipment B at $5,000. You could buy some of A and some of B, but relative pricing would mean comparing the value to you of 10 pieces of A versus 20 pieces of B. Assuming you choose 20 pieces of B, you effectively decide this is more valuable to you than 10 pieces of A.
Disadvantage 1: Time
Opportunity costs take time to calculate and consider. You can make a more informed decision by considering opportunity costs, but managers sometimes have limited time to compare options and make a business decision. In the same way, consumers going to the grocery store with a list and analyzing the potential opportunity costs of every item is exhaustive. Sometimes, you have to make an instinctive decision and evaluate its results later.
Disadvantage 2: Lack of Accounting
Though useful in decision making, the biggest drawback of opportunity cost is that it is not accounted for by company accounts. Opportunity costs often relate to future events, notes the Encyclopedia of Business, which makes it very hard to quantify. This is especially true when the opportunity cost is of non-monetary benefit. Companies should consider evaluating projected results for forgone opportunities against actual results for selected options. This is not to generate bad feelings, but to learn how to choose a better opportunity the next time.
- Comstock Images/Comstock/Getty Images