Have you ever asked yourself, "What in the heck is opportunity cost?" You're not alone. A lot of people talk about it, but few people really understand. The sad part about it is that it's not that complicated.
Simply stated, opportunity cost is the cost of everything you give up when you pick one course of action over another. In a real life example, how would you compute the opportunity cost of going back to school full-time to pursue an MBA degree? Let's explore the calculation.
You have an opportunity which presents you with two choices and you will need to compare. Option one would be to take a leave of absence from work, move out of town and pursue an MBA degree on a full time basis. Option two would be to maintain your job, stay at home and enroll in a local MBA program. An analysis of the options is presented below.
â€¢ Option One
Without preplanned or external financial support, option one (taking a leave of absence from work and moving out of town to pursue an MBA degree) would be extremely hard to accomplish. The average MBA program would require approximately two years of additional study. The opportunity costs during those two years could be estimated as follows:
Of note, although the financial costs listed above seem quite high, there is a benefit associated with option one that may be difficult to express in dollars. That benefit would be the availability of free time after the school day is complete to pursue leisure activities and spend time with family or friends.
â€¢ Option Two
Option two would be to maintain a job while enrolled in a local MBA program. Assuming the opposite conditions of option one, lost wages, medical/dental benefits, tuition reimbursements, additional subsistence or moving expense would not become an out-of-pocket cost to the individual making such as choice.
If, however, the individual must maintain a job while enrolling in a part-time MBA program, that individual may sacrifice a loss of increase in future wages due to the promotional opportunities lost between the number of years required to obtain an MBA on a part-time versus full-time basis. Assuming it would take twice as long to obtain an MBA on a part-time basis, the additional two years of MBA pursuit could be estimated at a $20,000 in lost future wages.
Of note, although much greater costs will be associated with option one, the availability of free time to pursue leisure activities would be greatly impacted by electing option two.
With the cost of both options calculated, it is now possible to calculate the opportunity cost of leaving home to purse an MBA (option one) and staying home and working while pursing an MBA (option two).
â€¢ Opportunity Cost of Option One over Option Two:
$138,700 (cost of option one) - $20,000 (cost of option two) = $118.700
In summary, calculating the opportunity cost of one option over the other gives an individual or a business a tool to help make an informed decision. While option one appears to have a greater financial impact, option two may have a much greater personal impact. However, the final decision is now possible with factual information. The final step is for the individual to determine which option is more highly valued â€“ financial gain or individual comfort. As a result, a totally objective decision can be made.
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If you are looking for more information on business management, you might be interested in some of the other articles I've written:
How to Create an Effective Performance Appraisal System, Qualities of an Effective Leader, Basics of How to Counsel an Employee for Improper Behavior, Understanding the Basics of Cost Accounting, Understanding the Importance of Organizational Behavior, Understanding the Use of Financial Ratios in Management of Working Capital