Opportunity cost

Opportunity cost says that what a thing costs you is what you could have had instead. A government that spends a billion on a bridge has given up the hospital the billion would have built. A company that keeps a team on a legacy product has given up the product that team would have shipped. The price on the invoice is only part of the cost and sometimes no part of it: a free ticket still costs you the evening. David Henderson's definition in the Concise Encyclopedia of Economics is the value of the next-highest-valued alternative use of the resource, and the arithmetic is the benefit you forgo minus the expense you avoid.

It holds because resources are scarce and every use of one excludes the others. Henderson's example is a student paying $4,000 a year in tuition while the state adds an $8,000 subsidy. That looks like the student pays a third of the cost. Add the $20,000 the student would have earned by working and the real cost of the year is $32,000, of which the student bears three quarters. That is also why tuition rises do not empty universities: a 10 percent rise on $4,000 is under 2 percent of what the year really costs. In practice the rule is to price every choice against the alternative that would actually have happened, never against doing nothing.

The concept is easy to state and surprisingly hard to apply, as the survey below shows. The alternative must be real and must be the best one: adding up every alternative you did not take double counts, and the next best use of a resource is a judgement people can disagree about. It is also a rhetorical weapon: "every dollar spent on X is a dollar not spent on Y" assumes the dollar would otherwise have gone to Y, which is usually false. And it can eat itself, since calculating the opportunity cost of every small choice is itself a cost. For the version that applies to hours and attention, see the opportunity cost of time.