Practice the concept of Opportunity Cost with examples

Example 1:
Steve bought a fully refundable plane ticket to Florida for Spring Break, which cost him $150. A week
before Spring Break, Steve’s roommate Harry invites Steve to come stay with him in New York over
break. Assume this is his only other alternative. Train tickets to New York cost $50, the only expense,
and Steve knows that he will get $250 worth of benefit if he goes to New York.

What is Steve's opportunity cost of going to Florida?

Example 2:
Steve bought a fully nonrefundable plane ticket to Florida for Spring Break, which cost him $150. A week
before Spring Break, Steve’s roommate Harry invites Steve to come stay with him in New York over
break. Assume this is his only other alternative. Train tickets to New York cost $50, the only expense,
and Steve knows that he will get $250 worth of benefit if he goes to New York.

What is Steve's opportunity cost of going to Florida?

Example 3:
Ellie's Tuesday morning class was cancelled. She now must decide how to spend her extra time. She has
three mutually exclusive options for activities. Go to the library and study for her Econ midterm, which
costs her nothing and which she values at $10, go to a movie, which costs her $5, and which she values
at $30, or have lunch with a friend, which costs her $10 and which she values at $55.

What is Ellie's opportunity cost of having lunch with her friend?

Example 1:
Steve bought a fully refundable plane ticket to Florida for Spring Break, which cost him $150. A week
before Spring Break, Steve’s roommate Harry invites Steve to come stay with him in New York over
break. Assume this is his only other alternative. Train tickets to New York cost $50, the only expense,
and Steve knows that he will get $250 worth of benefit if he goes to New York.

What is Steve's opportunity cost of going to Florida?

Solve
When calculating the opportunity cost, we have to include both the dollar cost of going to Florida and,
of course, also the opportunity cost of time, or the value of time.

The ticket would cost $150. And alternative use of time in this case is going to New York.

So, how will we value the value of time?

What we have to think about is what the net benefit of going to New York is? How much would Steve
get from going to New York minus the train ticket of going to New York?

He would have a benefit of $250, and that he would have to spend the price of a train ticket, which is
$50. So the net benefit is $250- $50, or $200.

When we think about the opportunity cost of going to Florida We want to add these two things
together. We want to add the dollar cost and the opportunity cost of time. So the true opportunity cost
of going to Florida will be $350.

This does not mean that he shouldn't go to Florida. If he values the trip at Florida at a very high price, if
he thinks that will be fun, by all means he should go to Florida. But Steve should be aware of the true
cost. And the true cost is not just the ticket, it's also the cost of his time.
Example 2:
Steve bought a fully nonrefundable plane ticket to Florida for Spring Break, which cost him $150. A week
before Spring Break, Steve’s roommate Harry invites Steve to come stay with him in New York over
break. Assume this is his only other alternative. Train tickets to New York cost $50, the only expense,
and Steve knows that he will get $250 worth of benefit if he goes to New York.

What is Steve's opportunity cost of going to Florida?

solve

The big difference here is that, we are told that the plane ticket to Florida is nonrefundable, and a
nonrefundable plane ticket is really money that has gone down the drain. This money is a sunk cost.

A sunk cost is money that has been paid and cannot be recovered. And if something is a sunk cost you
might as well ignore it because it's no longer money in your pocket. It's no longer money that you have
to spend.

So when we look at the numbers here, we have to realize that we can disregard the monetary cost of
the plane ticket. This is no longer a relevant piece of information again, because the ticket is a sunk cost.

There's still the alternative of going to New York. There's still a value of time. There's still the
opportunity cost of time. So we still want to take into account the net benefit of going to New York. But
now, the true opportunity cost of going to Florida is just $200. We do not want to include the $150.
Suddenly the opportunity cost of going to Florida is only $200.

So again, remember that if we have paid something already, and we cannot recover it. If there's some
sort of resource that we've used, and we can no longer recover that resource that resource is a sunk
cost, and we might as well disregard it. We will not take it into account when we calculate the
opportunity cost.
Example 3:
Ellie's Tuesday morning class was cancelled. She now must decide how to spend her extra time. She has
three mutually exclusive options for activities. Go to the library and study for her Econ midterm, which
costs her nothing and which she values at $10, go to a movie, which costs her $5, and which she values
at $30, or have lunch with a friend, which costs her $10 and which she values at $55.

What is Ellie's opportunity cost of having lunch with her friend?

we want to take into account both the cost of going to lunch and the opportunity cost of Ellie's time. The
difference is that in this example, Ellie has two alternative uses of her time. She could decide to go to
the library and study for her midterm. Or, she could decide to go to a movie.

So let's go ahead and calculate the net benefit of each one of these options. We'll take into account the
benefit, and we'll take into account the dollar cost. And the difference between the two will be the net
benefit.

If Ellie goes to the library, we're told that the benefit of studying is equal to $10, and we're also told that
the cost is zero. So the net benefit of going to the library is ten dollars. If Ellie goes to the movie, we're
told that the benefit of going to the movie is $30, but there's a cost of going to the movie and it is $5,
which means the net benefit of going to the movie is 30 minus 5, or $25.

Ellie can only do one of these two things. So, presumably she would choose the best of these things, or
at least we have to take into account the next best alternative. And the next best alternative is the
alternative with the highest net benefit. And in this case, it is going to the movie.

So, now we're ready to calculate the opportunity cost of going to lunch. And, we realize the opportunity
cost of going to lunch includes what? It includes the dollar cost of going to lunch, and it also includes the
opportunity cost of time, or the value of time. The cost of going to lunch, is equal to $10. The
opportunity cost of time is the foregone net benefit of the best alternative, which is the movie, so that
would be $25. and so we see that the opportunity cost of going to lunch is 10 plus 25, or $35.