Opportunity Cost

Opportunity cost is the value of the next best alternative forgone as a result of making a decision. Opportunity cost is a function of scarcity. Because of scarcity, people are faced with trade-offs in how they use their limited resources. For example, devoting the scarce resource of time to study economics means less time devoted to sleep. If, from an individual perspective, studying economics and sleeping are the two best alternatives for spending a given hour of time, then the cost of each can be expressed as the value of the other. So, an hour spent studying economics has an opportunity cost of one hour of sleep. As in the above example, opportunity cost is a convenient way to express the value of an item or course of action that has no explicit monetary cost or price.

Opportunity Cost vs. Accounting Cost

Though the concept of opportunity cost is used in financial applications such as capital budgeting, it is not used in accounting or in financial reporting. Accounting uses the concept of historical cost for valuation purposes.