Short Notes on Opportunity cost

In micro-economic theory, the opportunity cost, also known as alternative cost, is the value (not a benefit) of the choice of a best alternative cost while making a decision. A choice needs to be made between several mutually exclusive alternatives; assuming the best choice is made, it is the "cost" incurred by not enjoying the benefit that would have been had by taking the second best available choice. 

The New Oxford American Dictionary defines it as "the loss of potential gain from other alternatives when one alternative is chosen." Opportunity cost is a key concept in economics, and has been described as expressing "the basic relationship between scarcity and choice." The notion of opportunity cost plays a crucial part in attempts to ensure that scarce resources are used efficiently. Thus, opportunity costs are not restricted to monetary or financial costs: the real cost of output forgone, lost time, pleasure or any other benefit that provides utility should also be considered an opportunity cost.

Opportunity costs are a factor not only in decisions made by consumers, but in other decisions as well such as production, time management and capital allocation. When referring to opportunity costs, investors often see it as the benefits you would have received by taking an alternative financial action. The difference in return between a chosen investment and one that is the forgone alternative is essentially your opportunity cost. For example, if you invest in a stock and it returns only 3% over the year, and you gave up the opportunity of another investment yielding 8%, your opportunity costs are 8% - 3%, which is 5%. For example, there is an opportunity cost over choosing an investment in bonds over an investment in stocks.

(CMA DECEMBER 2013, EXAMINATION)