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Opportunity Cost

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PPGPortal > Home > Concept Dictionary > N, O > Opportunity Cost
 

 

Opportunity Cost

The value of the next-best forgone alternative that was not chosen because something else was chosen.

(from John B. Taylor, Economics, Fifth Edition, Houghton Mifflin, 2006)

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Opportunity cost is the cost of something in terms of an opportunity forgone (and the benefits which could be received from that opportunity), or the most valuable forgone alternative (or highest-valued option forgone), i.e. the second best alternative. For example, if a city decides to build a hospital on vacant land it owns, the opportunity cost is the cost of some other thing which might have been done with the land and construction funds instead. In building the hospital, the city has forgone the opportunity to build a sporting center on that land, or a parking lot, or the ability to sell the land to reduce the city's debt, since those uses tend to be mutually exclusive. Also included in the opportunity cost would be what investments or purchases the private sector would have voluntarily made if it were not taxed to build the hospital. The total opportunity costs of such an action can never be known with certainty (and are sometimes called "hidden costs" or "hidden losses,” because what has been prevented from being produced cannot be seen or known).

The concept of opportunity cost is nicely demonstrated in parable of the broken window created by Frédéric Bastiat in his 1850 essay Ce qu'on voit et ce qu'on ne voit pas. The parable describes a shopkeeper whose window is broken by a little boy. Everyone sympathizes with the man whose window was broken, but pretty soon they start to suggest that the broken window makes work for the glazier, who will then buy bread, benefiting the baker, who will then buy shoes, benefiting the cobbler, etc. Finally, the onlookers conclude that the little boy was not guilty of vandalism; instead he was a public benefactor, creating economic benefits for everyone in town.

The fallacy of the onlookers' argument is that they considered the positive benefits of purchasing a new window, but they ignored the opportunity costs to the shopkeeper and others. He was forced to spend his money on a new window, and therefore could not have spent it on something else. Perhaps he was going to buy bread, benefiting the baker, who would then have bought shoes, but instead he was forced to buy a window. Instead of a window and bread, he had only a window.

The failure to account for opportunity costs is common in popular thinking. Indeed, one can equate the glazier with special interests, and the little boy with government. Special interests request money from the government (in the form of subsidies, grants, etc.), and the government then raises the funds from taxpayers. The recipients certainly do benefit, so the people as benefitting everyone often regard the government action. However, this fails to consider the opportunity costs: the taxpayers are now poorer by exactly that much money. The food, clothing or other items they might have purchased with that money will now not be purchased -- but since there is no way to count "non-purchases," this is a hidden cost (opportunity cost). Examples of special interest groups practicing the broken window fallacy might be: arguments against reduction of low-productivity government jobs.

References

Ian Clark, drawing on Wikipedia

     

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© University of Toronto 2008
School of Public Policy and Governance