The Opportunity Cost of Capital

1 Opportunity Cost of Capital The concept of opportunity cost plays a significant role in economics. It refers to the benefits that a potential investor foregoes when they select one alternative over another.

Opportunity costs are not tangible or visible; therefore, they can easily be disregarded when making an economic decision. Understanding this concept facilitates effective decision-making.

To select the option that will yield the most benefit, it is important to examine the cost and benefit of each of the available options.

The opportunity cost formula is: Opportunity Cost = Foregone Option – Current Option Opportunity cost is a major concept in economics because it is used in making day-to-day decisions in society where the opportunities that present are always more than the resources; thus, they must be allocated to the most effective use.

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An example of opportunity cost is when you have a busy week that leaves you feeling fatigued. Instead of resting on the weekend, you spend the entire weekend traveling, which leaves you more drained and unable to function effectively the following week. The best alternative use of your energy would have been to take some time to rest. The opportunity cost of failing to rest is fatigue, and subsequently, the inability to function optimally the following week.

Another example of opportunity cost is deciding whether to invest their savings in business or on buying the shares of a company. If they invest in the shares, they will have to forego the profits they might have earned from the business, and if they invest in the business, they will have to forego the interest they might have earned from the appreciation of the value of the shares. Therefore, it is important to make a well-calculated decision to ensure that the selected option yields maximum value.

3 References Veseth, M. (2014). Introductory Microeconomics. Elsevier Science.