opportunity cost
The value of the next best alternative you give up when making a financial decision.
Example
“The opportunity cost of buying a car was the investment returns she could have earned with that money.”
Memory Tip
What OPPORTUNITY did you give up? Every choice has an opportunity cost — the next best thing you didn't do.
Why It Matters
Understanding opportunity cost helps you make better financial decisions by considering not just what you gain, but what you lose. Every dollar spent on one thing cannot be spent on another, so recognizing these trade-offs prevents you from making choices that seem good in isolation but are actually poor compared to your alternatives.
Common Misconception
Many people think opportunity cost only applies to money, but it also includes time and other resources. A common mistake is ignoring opportunity costs altogether and focusing only on the direct benefits of a choice, leading to decisions that waste valuable resources on inferior options.
In Practice
If you have 10,000 dollars and can either invest it in stocks earning 8 percent annually or keep it in a savings account earning 1 percent, the opportunity cost of choosing the savings account is 700 dollars per year in foregone investment gains. Similarly, if you spend 4 hours watching television, the opportunity cost might be the 50 dollars you could have earned working a part-time job during that same time.
Etymology
Opportunity (a favorable circumstance) + cost — the cost of missing other opportunities.
Common Misspellings
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See Also
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