alternative. Typical examples of decisions involving opportunity cost include
the following:- What is the opportunity cost of pursuing an MBA degree?
- What is the opportunity cost of using excess factory capacity to supply
specialty orders? - What is the opportunity cost that should be imputed to city-owned
land that is to be the site of a public parking garage downtown?
As the definition suggests, an estimate of the opportunity cost in
each case depends on identifying the next-best alternative to the current
decision. Consider the first example. Suppose the MBA aspirant has been
working in business for five years. By pursuing an MBA degree full time,
what is he giving up? Presumably, it is the income he could have earned from
the present job. (This opportunity cost is larger or smaller depending on
how remunerative the job is and on the chances for immediate advance-
ment.) Therefore, the total cost of taking an MBA degree is the explicit,
out-of-pocket tuition cost plus the implicit (but equally real) opportunity
cost.^1
Next, consider the case of excess factory space. Assuming this space
otherwise would go unused, its opportunity cost is zero! In other words, noth-
ing is given up if the extra space is used to supply the specialty orders. More
realistically, perhaps, one would assign a small opportunity cost to the capacity;
committing the space to the specialty order might preclude using it for a more
profitable “regular” order that might arrive unexpectedly.
Finally, consider the case of the city-owned land. Here the opportunity
cost is whatever dollar value the land could bring in its next-best alternative.
This might mean a different, more profitable city project. In general, an
accurate estimate of the land’s alternative value is simply its current market
price. This price reflects what potential buyers are willing to pay for
comparable downtown real estate. Unless the city has a better alternative
for the land, its next-best option will be to sell the land on the open
market.
As the first and third examples illustrate, opportunity costs for goods, serv-
ices, or inputs often are determined by market prices (assuming such markets
exist). For instance, the opportunity cost of the full-time MBA student’s time
is his forgone wage (determined, of course, by labor-market conditions). The
cost of the city-owned land is its market price. Note that if the city did not own
the land, its cost would be explicit; it would have to pay the market price to228 Chapter 6 Cost Analysis(^1) Here are some questions to consider: What is the opportunity cost of pursuing an MBA degree
part time at night while holding one’s current job? For a 19-year-old, what is the opportunity cost
of pursuing an undergraduate business degree?
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