Opportunity Cost Examples
Opportunity Cost is the benefit that an individual is losing out by choosing one option instead of another option. A simple example of opportunity cost is to let us suppose that a person is having Rs. 50000 in his hand and He has the option to keep it with himself at home or deposit in the bank which will generate interest of 4% annually so now the opportunity cost of keeping money at home is Rs. 2000 per year as opposed to Bank.
The following Opportunity Cost Examples provide an outline of the most common Opportunity Cost.
Top 7 Examples of Opportunity Cost
- Graduation Versus Salary
- Stocks Versus Cash
- Vacation Versus training
- Paying off debt Versus Spending on Welfare by the government
- Entrepreneurship versus steady job
- Selling Stocks now and 2 months later
- Investing in stocks or higher degree
Let us understand these examples in detail:
Example #1 – Graduation Versus Salary
A person named X is currently working in a company and drawing some salary. X is getting an option to do the graduation for 2 years but for that he/she must leave his/her job. If he/she doesn’t go for graduation, the opportunity cost will be higher degree plus the additional salary that he/she might get because of this degree. On the other hand, if he/she opts for the job then the opportunity cost will be 2 years’ salary that has to be foregone.
Example #2 – Stock Versus Cash
Let’s say you got $50,000 in your bank account which you don’t need right away. You can have many options with this cash. For example, you can just keep this cash, or you can invest this money in stocks. Let’s say if you would have invested wisely that money in some good stocks and after a year 50,000 would become $60,000. On the other hand, if you keep this money idle instead of investing in cash then your opportunity cost will be the difference between 60000 and 50000 i.e. $10,000
Example #3 – Vacation Versus Training
Your school has announced a vacation. You finally get a chance to go for the holidays for the next 1 month. But suddenly you came to know that training is scheduled for your favorite sports which you do not want to miss. So, if you go on vacation then your opportunity cost will be missing the training session and if you stay for training then your opportunity cost will be enjoying the vacation.
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Example #4 – Paying off Debt Versus Spending on Welfare by Government
A country’s government is preparing its budget. It is having some surplus which can be used for paying off its debtor can be used for introducing some welfare schemes for its citizens such as subsidy. If it pays off its debt instead of a welfare scheme, then that would be classified as an opportunity cost for its citizens.
Example #5 – Entrepreneurship Versus Steady Job
You are having a steady job with a good income, but your passion is to open your own business which required you to leave your current job and you have to spend a lot of money on opening business initially. You are having both options. If you are choosing a steady job instead of opening a new business, then your opportunity cost will be not having work you wanted and maybe success because of the new business. If you start your business, the opportunity cost would be a steady job and a paycheck from it.
Example #6 – Selling Stocks Now and 2 Months Later
You are having shares of a company worth $5,000. You are thinking of selling that shares now or wait for 2 more months. Let’s say after 2 months shares would be worth $6,000. If you sell the shares now, then your opportunity cost would be 6000-5000= $1,000 which you could have got if you would have waited for 2 more months.
Example #7 – Investing in Stocks or Higher Degree
You have got $20,000 in which you are thinking of either investing in shares of some company or you can invest this money in getting a higher degree in a good university. If you invest in stocks, then your opportunity cost would be higher degrees and a higher salary because of the degree. But if you invest in a higher degree then your opportunity cost would be profit gained from those shares.
Opportunity Cost Practical Example (IBM Acquiring Red Hat)
In Oct 2018, IBM announced that it is going to acquire Red Hat for a total deal value of $34 Bn. Red Hat is an open-source software company that is mainly in the cloud market. IBM is trying to strengthen its cloud business for long and this acquisition could prove a crucial point in its strategy. Red Hat shareholders will receive $190 per Red Hat shares with this deal. Now below is IBM’s balance sheet as per 2018 annual report:
As we can see that in their books, they are having Cash and Equivalents of around $11.4 Bn. They are also issuing debt for paying for this deal. Instead, they could use this money for paying a dividend to its shareholders or opening a new R&D center. So, the opportunity cost for IBM shareholders will be this dividend or profit from some new R&D center if IBM had not done this deal.
Opportunity Cost is a very important concept if an individual/company wants to think rationally between the options. With this strategy, a firm can think that what it is foregoing with choosing the option. Companies use this concept for any capital or investing decision while calculating “Cost of Capital”. By the above-mentioned examples, you can understand what it means and how it can be applied in different scenarios to choose between the option.
This has been a guide to Opportunity Cost Examples. Here we discuss its definition and the top 7 examples along with detailed explanations. You can learn more about financing from the following articles –