What Is Opportunity Cost? Definition, Formula and Examples

Opportunity cost – what is it? It’s a concept in economics which says that every decision involves giving up the potential benefits you could have gained from another available option. Imagine you have a choice: spend the evening watching Netflix or go to the gym. The opportunity cost is the value of the option you give up, that is, the value of the forgone benefits. When you have two options to choose from, the opportunity cost is what you could have had but gave up.

This concept helps you understand how to make a decision, both in everyday life and in personal finance. Knowing how to calculate opportunity cost (I’ll show you an example later in the article) you can consciously choose between saving, spending, investing and paying off a loan. It’s like having a superpower that lets you see what we really lose by choosing one option instead of another.

Without understanding opportunity cost, you can get stuck in an endless cycle of making decisions that don’t always bring you the greatest benefits.

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Opportunity cost – a definition

In classical economics it is the value of the best possible option that we give up in favor of another decision. In other words, if your choices are to look after your niece, watch a TV series, spend the day at the beach or work on a project, the opportunity cost is the money you didn’t earn by choosing the beach. Or the other way round: the opportunity cost can also be the sunny day that’s lost when you decide to work.

Every decision involves losing the potential benefits of the option not chosen. It’s like choosing between a doughnut and a healthy salad – every decision has its costs – not only the ones expressed in money. It’s also the lost pleasure of the sweet treat, the lost health from eating sweets, the lost pleasure of lounging on the beach or the lost chance to strengthen family bonds.

In the modern approach to personal finance, opportunity cost takes into account not only the financial aspects, but also time, energy, other resources and a sense of happiness. Understanding opportunity cost will help you see how to make a decision that’s more beneficial for you, that is, for your long-term happiness. After all, life is not just numbers or money, but wise choices!

So if you’re wondering how to make a decision about changing jobs, start by carefully analyzing the opportunity costs from every angle. When you’re done, you’ll have a lot of information – not only financial, but also related to what matters to you in life.

Should Taylor Swift cook her own dinners?

To make it easier to understand what opportunity cost is, I’ve prepared a rather vivid example. Imagine Taylor Swift in the kitchen, trying to cook herself dinner. Nice sight, right? But should she really be doing it? This is where opportunity cost comes in. How do you calculate it?

The time Taylor spends cooking she could devote to writing a new hit or recording another album. How much is her time worth? Probably quite a bit more than the cost of even the most exquisite dish in the most prestigious restaurant.

If our talented artist nonetheless decides to experiment in the kitchen, the opportunity cost in this example is the potential earnings from a new hit that Taylor gives up by choosing to cook. Or giving up the income she could receive in exchange for promoting some brand on her Instagram. Or instead of giving an interview to some TV or radio station.

So should Taylor Swift cook her own dinners? Probably not, unless it’s her way to relax and find inspiration. But that opens the door to further reflection: will experimenting in the kitchen be more relaxing for her, or going for a walk or reading a book?

Do an exercise to understand how opportunity cost works: come up with your own examples. Make them vivid, exaggerated, tied to your favorite celebrities or people you admire. Work out what they lose by choosing one option instead of another. We learn the most by doing things ourselves, so coming up with examples of opportunity cost on your own will certainly help you best understand what it is.

Knowing how to calculate opportunity cost helps you make important decisions, whether you’re a pop star or you’re simply wondering whether it’s worth investing or overpaying your loan. Or more concretely: whether it’s better to walk one bus stop, pay 4.50 PLN for a bus ticket, or maybe 9 PLN for an Uber.

Opportunity cost in personal finance

Opportunity cost is not just a definition and dry economic theory – it’s something that affects our wallets and our lives every day. For example, have you ever wondered whether coffee from a café really tastes better than the one made at home? And how much better does it taste? Is it worth the difference in cost? Or maybe it is worth it, because you save time you can spend on earning money?

So, short and simple: opportunity cost – what is it? It’s the greatest forgone benefit tied to your decision. When we decide to buy a flat or to rent, we also face a choice. Understanding opportunity cost helps determine how to make an important and conscious financial decision, so as to manage our resources as well as possible. This is about money as much as our energy, motivation and time.

Since people learn fastest by doing, maybe some exercises will help you understand what opportunity cost is? Don’t worry, this is not university or school, I won’t force you into anything. To show what opportunity cost is, I’ve prepared examples, but if after reading them you still have trouble grasping the concept, try creating your own examples and calculating them yourself.

Coffee from a café or at home?

Imagine a morning: you wake up, the sun is shining, and you’re dreaming of an aromatic coffee. Now comes the dilemma – coffee from a café or at home? The choice seems simple, but is it really? To calculate opportunity cost you don’t need a formula; it’s a very intuitive concept.

Let’s say a coffee from your favorite café costs 15 PLN. If you reach for this pleasure every day, you spend about 450 PLN a month. Meanwhile, by making coffee at home you’ll save a sizable sum, which you can put toward savings or investments. You can buy cheap instant coffee from Lidl for 20 PLN, branded instant coffee for 40 PLN, or ground coffee, which will be cheaper but takes longer to prepare. Or it might even be worth buying a coffee machine and whole-bean coffee.

What’s more, the concept of opportunity cost is not only about money. By choosing coffee from a café, you also lose time waiting in line or getting there. Or maybe you’d rather spend those minutes on meditation or a morning run? The decision is yours, but remember: every option has its pros and cons. The important thing is to make a conscious decision, enjoying your favorite coffee without a guilty conscience.

How much does a 3,000 PLN TV cost?

The behavioral approach to personal finance treats opportunity cost as a metaphysical concept, used to compare happiness, contentment, satisfaction and other emotions. The traditional school of economics, however, treats opportunity cost, its definition and formula in a more mathematical way.

In microeconomics classes, students working through opportunity cost solve problems by counting above all the financial aspect of a decision. They completely ignore qualitative aspects such as emotions, preferences and the force of habit. The example below shows precisely this financial approach to opportunity cost.

Let’s say you bought a new TV for 3,000 PLN. You think that’s exactly what it cost you? Imagine that instead of this TV, you invest 3,000 PLN in a deposit or treasury bonds with a real rate of 3%. After a year you have 3,090 PLN – the gain is 90 PLN. So your new TV actually cost you not 3,000 PLN, but 3,090 PLN, because that’s the amount you could have had if you’d invested the money.

Looking at opportunity cost through an example makes it easier to understand how to make a financial decision and what the consequences of our choices are. Next time you plan a big purchase, remember to factor in opportunity cost; how do you calculate it? It’s dead simple, and it can save you not only money but also a lot of dilemmas!

Vocational school or university?

A primary-school graduate facing a decision about their future can carefully calculate whether it’s really worth going to high school and university. The alternative is choosing a vocational school.

By choosing a vocational school, they enter the job market sooner. This way they gain experience and start earning earlier. The cost is giving up the potentially higher earnings that university and a degree could bring. By choosing university, they invest more time and money in education, but those aren’t the only costs. The biggest cost is the salary they could have earned by working right after vocational school.

Every option has its pros and cons, and the key to success is understanding what the opportunity cost is. How will that help a future primary-school graduate? They’ll be able to make the decision that best fits their goals and life situation, even if they hadn’t considered it before. They’ll be able to plan their future more effectively.

Remember that the cost of going to university is not just renting a room, photocopying materials and parties. It’s also the lost salary you could earn as a Lidl employee (i.e. 3,875 PLN net per month in 2024), a mechanic, or airport ground staff. That is exactly the opportunity cost. How do you calculate it? Let’s assume that, instead of holidays in July and August, our student found a job. Then the opportunity cost is the lack of a salary for 10 months over 5 years.

3,875 net per month x 10 months x 5 years = 193,750 PLN

Will the salary after university really be so much higher that it makes up for those lost earnings?

Buying a flat or renting?

When choosing between buying a flat and renting, it’s also worth calculating the opportunity cost. What can it tell you, and how do you go about it?

By buying a flat, you invest in a property that may gain value over time. However, you probably need a mortgage, so you have to put up a sizable sum for the down payment and you’re responsible for all repairs and renovations. What is the opportunity cost in this case? The benefits you get from renting.

You lose flexibility, because when renting you can change locations whenever something isn’t to your liking or your life plans change. What’s more, you don’t have to put up a down payment – you can save and invest that money. This analysis can be flipped, too. When renting, the whole rent goes to someone else. With a loan, part of your housing spending is actually saving, that is, paying off the principal instalment.

Let’s say your choice is between buying a flat for 500,000 PLN or renting for 3,000 PLN a month. Buying the flat, you have to put up at least 60,000 PLN for the down payment and bear the loan costs, which will come to about 2,000 PLN a month. With this data, you can work out the opportunity cost (in financial terms) for both buying and renting.

But remember that the opportunity cost also includes non-financial aspects, such as your lifestyle, plans for the future, freedom or comfort.

Opportunity cost in investing

Besides purchasing and career decisions, opportunity cost works great when making investment decisions. It helps you decide whether it’s better to invest or to overpay your loan. Whether it’s better to keep money in an account and a deposit, or perhaps invest in something more profitable? If you keep your money in a low-interest savings account, you lose the chance to earn higher returns from investing.

When making investment decisions, it’s always worth thinking about opportunity cost. University problems often go like this: an investor, by investing in the shares of one company, gives up the potential gains from another investment, e.g. bonds or real estate. The opportunity cost is the value of those untapped possibilities. Think it over before you invest all your savings in the shares of a company that makes only unicorn T-shirts.

Risk and return always go hand in hand with opportunity cost. Higher-risk investments can bring a greater return, but the cost is a loss of security. Safe investments, in turn, like bonds, give a smaller return but are more stable. The decision is yours – do you prefer a peaceful sleep or the adrenaline of stock-market frenzy? Remember that opportunity cost will help you find the right balance.

How do you calculate opportunity cost? The opportunity cost formula

A great many formulas in economics are addition and subtraction, sometimes multiplication. It’s similar with opportunity cost. The formula is simply subtraction, since it’s the value of what you lose by choosing one option instead of another.

Opportunity cost = Gain from the chosen option – Gain from the best option not chosen

An example of how to make a decision about changing jobs will show you what opportunity cost is and how to calculate it. Imagine your choice is: stay in your current job and earn 50,000 PLN a year, or accept a new offer for 60,000 PLN. The cost of staying in the old job is the difference in earnings, that is, 10,000 PLN (about 830 PLN a month).

But on the other hand, if you feel good in your current job, you have an easy time and great colleagues, is it worth leaving all that for 830 PLN a month? So how do you make a decision about changing jobs? Besides the financial calculations, you can also compare commutes, differences in spending on food and other costs you bear – both financial and emotional.

And what about investing? Let’s say you have 10,000 PLN and you can invest it in bonds with a 3% rate of return or in shares with a potential return of 7%. If you choose bonds, the opportunity cost is the difference between the return on shares and the return on bonds, that is

7%−3%=4%

In numbers, that’s 400 PLN a year that you could have earned extra by choosing shares. Of course, gains alone aren’t everything; you also have to take into account your risk tolerance for the opportunity-cost analysis to be complete. Now do you know whether it’s worth estimating opportunity cost? What will this tool give you? It will let you better understand what you really lose by choosing one option over another, make you think, and simplify the decision-making process.

Summary

Opportunity cost is not an example of dry economic theory. It’s a tool that helps you make smarter decisions. On one hand, you have to calculate the financial dimension of giving up something else, and on the other, it requires thinking about how important the advantages of the option we want to reject are to us. Understanding what opportunity cost is lets us better assess the consequences of our choices, both in everyday life and in finances.

Keeping opportunity cost in mind helps avoid decision-making traps. Instead of focusing only on direct costs, we can understand the full picture of our decisions. It’s a tool for assessing how to make an important decision.

Applying the concept of opportunity cost in everyday life motivates us toward more conscious choices, and understanding it can be the key to improving our financial situation and achieving long-term goals. So next time you face a choice, think about what you really lose, and make the decision that best fits your lifestyle.