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Opportunity cost

Opportunity cost is a term used in economics, to mean the cost of something in terms of opportunity foregone. For example, if a city decides to build a hospital on some vacant land, the opportunity cost is the other things that might have been done with that same land instead. In building the hospital, the city has forgone the opportunity to build a sporting centre, or a car park, or sell the land off to reduce debt, and so on.

The simplest way to estimate the opportunity cost of an economic decision is to consider the next best alternative choice that could have been made, even though in reality most economic decisions involve multiple alternatives. Note that opportunity cost is not the sum of the available alternatives, but rather any particular one of them - the opportunity cost of the decision to build the hospital is the loss of the sporting centre or the loss of the money to be made from selling the land, or the loss of any of the various other possible uses, not all of these in aggregate.

It is often important to compare the opportunity costs associated with various courses of action. Different opportunities may be difficult to compare along all the relevant dimensions. Economists typically use the going market price of each alternative. This can lead to considerable difficulty in the case of alternatives that do not have a market price. It is very difficult to agree on a way to place a dollar value on intangible assets. (How does one calculate a dollar value for clean air, or seaside views, or pedestrian access to a shopping centre, or untouched virgin forest?)

In consequence, intangibles tend to be ignored, and the powerful concept of opportunity cost, although widely recognised as one of the very few profound "eternal truths of economics" (1 (http://www.ceda.com.au/Research/Bulletin/Governments%20and%20markets-Peter%20Drake.htm)), is often stripped of meaning.

While opportunity costs are widely under-estimated, particularly by groups with a particular political or financial gain in mind, the opposite tactic is employed too. Here, the proponent of a particular point of view exaggerates an opportunity cost as a political tactic. A good example is the computer software industry, which regularly calculates the "opportunity cost" of software piracy by assuming that, if piracy did not exist, every individual with an illegal copy of any particular program would have chosen to pay the full retail price to buy the legitimate packaged version instead - thus neatly ignoring another of the eternal truths of economics, that marginal demand always falls as prices rise.

Nevertheless, although it is hard to account for, opportunity cost is very real. Because opportunity costs are so hard to calculate, they represent the hidden cost[?] of an economic decision. Frederic Bastiat suggested that ignoring hidden costs can make certain decisions appear to have no cost at all. He described this as the broken window fallacy.

Since the work of the Austrian economist Friedrich von Wieser opportunity cost has been seen as the foundation of marginal theory of value.

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