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Paul Hoang of Sha Tin College, Hong Kong, discussesa number of illustrations of the first concept introducedto a new student of economics.

What is

Opportunity Cost?AQA ✓ 1(10.1)

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hese quotes refer to theeconomic costs of raising

children in today’s society. Butbefore we consider this example ofopportunity cost we need to define thisconcept. Opportunity cost is defined asthe best alternative that is foregonewhen making a decision. Due tounlimited resources, such as time andmoney, we are confronted with choices.The study of economics assumes thatpeople are rational decision makers, i.e.they choose the option that gives themthe most benefit. Opportunity costdiffers from ‘accounting costs’ in thataccounting costs do not look at the cost(or value) of foregone choices. Forexample, if a student decided to go intohigher education, the accounting costwould include the tuition fees and othercosts associated with studying atuniversity. However, opportunity costalso considers the foregone income thatcould have been earned had the personchosen to work (the best alternativechoice) instead of studying. Of course,the student would hope that by studyingfor a degree that he or she would earn ahigher salary in the future to offset boththe accounting and opportunity costsassociated with studying. Hence, theconcept of opportunity cost is usefulwhen assessing the true costs andbenefits of competing choices.

We now look at various applications ofopportunity cost.

The economics of children…Children represent an economic cost.This not only refers to the cost of havingand raising children but also theopportunity cost of having children, i.e.what else parents could have done withthe money had they chosen the nextbest alternative. Instead, parents havechosen to spend their time and moneyon children. Such decisions benefitbusinesses that are involved in toys,clothing, computer games andaccessories, stationery, education andsports. There is a huge market to beexploited and companies such asToys R Us and Mattel have becomemajor global businesses as a result.

The opportunity costs of children have

become more apparent as can beobserved through demographicchanges. One demographic change thatcan be observed in most developedcountries is the decline in birth rates.This is largely due to the growing numberof women who are choosing to havechildren at a later age due to their careeraspirations. However, the other majorreason is to do with the opportunity costof having and raising children. Some ofthe expenses that parents might need tofund include a combination of the itemsin Box 1.

The concept of opportunity costapplies to high income earners as well

as those with low incomes. In fact, thosewith high incomes may have fewerchildren because of the high opportunitycost of a working parent spending timeon a young child’s upbringing. There is alarger opportunity cost to the person(such as famous sports women andfemale celebrities) as they could haveearned a lot of money in their profession.

The opportunity cost of timeThe phrase ‘Time is money’ is ofabsolute relevance in the businessworld. For example, there can be a hugeopportunity cost of being late for a jobinterview, delays caused by traffic

T❝The idea that buying a house is the biggest investment mostpeople are likely to make does not take into account theinvestment Australian parents make in raising their children. ❝

All you need is love …andaround AUS$450,000 (that’sover £191,000!)

Source: AMP (www.amp.com.au), an Australian financial institution

Box 1: The economic costs of having children

� Hospital fees – a private maternal ward at the Matilda Hospital in HongKong costs HK$56,000 for three days (that’s over £1,300 per day!). InPortland Hospital, London, the cost is between £7,000 and £10,000depending on the level of service required.

� Groceries – from baby nappies and milk powder to lunchboxes for school.

� Hobbies – many sporting and leisure activities can prove very expensivefor participants (and their parents).

� Private tuition – such as private music lessons or academic tuition forexams.

� Compulsory Education: kindergarten, primary and secondary. Costs might include: uniforms, stationery and textbooks. According toMoneyCentral.com, the cost of education accounts for 7-11% of theaverage American household income. Private sector education, inboarding schools say, will obviously inflate the costs for parents. Britishmedia sources reported that private schooling costs an average of£71,050 for a day student (who returns home at the end of the school day)and an extra £130,450 for a boarding student (who stays on campus).

� Tertiary education: University fees and maintenance costs, such as rent.In November 2006, The Independent reported that “steep rises inuniversity fees have pushed the average cost of bringing up a child tomore than £180,000.” University tuition fees were also reported to haveincreased three times more than the rate of inflation.

� Deposit for a car/home.

� Gap year expenses.

� Holidays – additional cost of flights, accommodation and entertainment.Most airlines will charge for children aged 2 and above for a ‘seat ticket’.

� Health services – a visit to a private doctor costs HK$350 (approx. £25) fora general consultation that might last no more than 2-3 minutes.

� Wedding – the average cost of a wedding is AU$36,234 (£15,400) inAustralia (Source: Bride to be magazine, Cost of Love Survey 2004) andUS$19,000 (£9,600), excluding the honeymoon, in the USA (Source: Bridesmagazine).

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congestion or missing paymentdeadlines to a bank. Businesses realisethat customers do not like to wait.Minimising waiting time is not alwaysfeasible, such as queues at a doctor’sclinic. Nevertheless, there are plenty ofexamples of how businesses put theconcept of opportunity cost intopractice.� Mirrors have long been used in places

with lifts (elevators), such as in hotelsand department stores. Customersdo not necessarily notice the waitingtime – and hence refrain from beingannoyed at the business – as theystare at themselves in the mirror! Thesame reasoning applies whencustomers enter the lift – there aremirrors inside too.

� Music and entertainment is a majorfeature at many theme parks. TheDisneyland Company tries to reducetime-conscious customers byproviding music, live entertainmentand use of large movie screens todistract customers whilst they wait inline for thrill rides and otherattractions. This all helps to provide abetter overall experience for theircustomers.

� Whilst waiting at the checkouts at any

supermarket, you may notice the‘bins’ next to the counter. These are alast minute attempt by the super-markets to lure customers to buymiscellaneous items (hence the term‘bins’) such as confectionery andbatteries. The other purpose is, again,to distract people waiting in thequeue.

� In many countries, the multinationalPizza Hut offers their customers freepizza if their order is not deliveredwithin 30 minutes. This practice maygive Pizza Hut a competitiveadvantage over its rivals, initially, butrivals simply copy the idea.Nevertheless, the principle ofopportunity cost is again at the centreof this business decision.

� Airline companies often overbook thenumber of seats of a flight. This isbecause, statistically, flights are rarelybooked at full capacity. However, as aresult of the policy, sometimes airlinesface the problem of overbooking andwill need to ‘bump’ customers, i.e. tooffer them compensation for havingto wait for the next available flight. Tothe person who values time lessconscientiously, they may purchase astand-by ticket which is cheaper butmore inconvenient.

� Public transport has also beentargeted by the business world.Television advertising is now quitecommon on buses and trains. Thisnot only helps the transport com-panies, such as Virgin Trains, toreceive advertising revenue, but mayalso distract travellers from ‘countingthe minutes’ on a journey, therebymaking the experience a little moreenjoyable.

� Women’s clothes retailing is amassive business. However, womenare often accompanied by theirhusbands and boyfriends who tend tohave less patience in a shopping mall– look out for this trend next time youare out shopping! Marketers havenoticed this fact and have responded.Many retail outlets now providenewspapers and male-orientatedpublications (such as motor vehicleor male fashion magazines) so thatthe girlfriend or wife can shop inpeace! The retail outlets, of course,hope that this strategy will then allowthe customers to spend much longerin their shops, thereby increasing thechance of more sales.

� Banks make their money mainly bylending the deposits from theirsavers. Hence, they will reward thesavers that can ‘lend’ the bank moneyfor a longer period of time. Savingsaccounts that are instant access(savers can take their money outwithout any notice) attract a lowerinterest than deposits made in a long-term savings account. At the time ofwriting, a HK$1,000,000 deposit(approx. £70,000) at HSBC in HongKong will give a return of 2.75%whereas the same deposit for twoyears gives the saver 3.55% perannum. So, time really is money in thebusiness world. Similarly, Table 1shows the various rates of interest forsavings with Halifax plc (one of theUK’s largest mortgage providers). Ascan be seen, the longer someone

Table 1: Interest rates for HalifaxStepped Income Reserve savings

accounts, from 1st June 2007

Year 1 4.95%Year 2 5.20%Year 3 5.45%Year 4 5.70%Year 5 8.00%Source: http://www.halifax.co.uk/savings/personalrates

Those who buy stand-by tickets are valuing cost savings more than convenience.

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saves their money, the greater thereturn on their money.

� 7-Eleven stores, the Japanese-ownedmultinational company, chargeshigher prices than supermarkets forthe same products. The surcharge is‘justified’ as most of their stores areopen 24-7 and so customers areexpected to pay for this convenienceand the opportunity cost of having topay higher wages to staff who workunsociable hours. Customers are alsolikely to be willing to pay more for theirown convenience of being able topurchase items from 7-Eleven whenother retail outlets are closed.

� Opportunity cost also extends to thehealth care industry. There are hugewaiting lists in the National HealthService, which is funded by taxpayersand provided by the public sector.However, if a patient chooses to ‘goprivate’ then he or she may even beseen right away by a doctor. This, ofcourse, comes at a price but again theexample shows that the concept ofopportunity cost is at play.

� London congestion charging cameinto effect in February 2003. Thismeant that drivers entering thecontrolled zone at peak times inLondon were charged £5 per day.Within a few months, traffic had fallenby around 20%. The charge (or tax)has since been raised to £8 per day.Motorists, as a result, have to askthemselves whether the congestioncharge is a price worth paying. Theopportunity cost may be that the £8could have been better spent onsomething else, such as a meal – inwhich case the rational motoristwould choose not to drive into CentralLondon. However, if the opportunitycost was delivering valuable stocksto an important client, then the £8charge may be minuscule.

� Supermarkets in the UK realised theopportunity cost of being ‘closed’ onSundays. It was not until the mid-1990s that supermarkets wentagainst government advice andbegan to trade on Sundays. Theywere fined for such actions, aslicensing to trade on Sundays had notbeen enacted, but the fine was soinsignificant compared to therevenues that they were earning byopening on Sundays that thesupermarkets continued with thispractice. Banks in Hong Kong arecurrently contemplating opening onSundays.

� Even governments are waking up tothe opportunity cost of neglecting theenvironment. In February 2006, TheDaily Telegraph discussed whetherparents who use reusable nappies fortheir babies should receive cashbenefits. This could give parents anincentive to switch away fromdisposable nappies which are notbiodegradable. The Republic ofIreland has used a ‘plastic carrier bag’tax since 2002. The opportunity costof not bringing your own bag (i.e. notrecycling carrier bags) is the tax paidon each bag issued by a retailer. TheBBC reported that this act has led tomillions of euros in tax revenues anda 95% fall in the use of plastic carrierbags.

1. What is meant by the concept ofopportunity cost?

2. Why do children present an oppor-tunity cost to their parents?

3. If opportunity cost cannot beaccurately measured, does thismean it has limited use?

4. Why do banks tend to offer higherrates of interest for customers whocannot have instant access to theirsavings?

5. To what extent does an understand-ing and awareness of opportunitycost help to reduce environmentaldamage?

Questions for discussion

Summary of key points� Opportunity cost is the cost measured in terms of the next best option

that is foregone when making a decision.

� Opportunity cost is at the heart of decision making, whether there is aconscious or subconscious awareness of the concept.

� Due to scarce resources, including time and finance, competingdecisions need to be made and any decision that involves a choicebetween options will incur an opportunity cost.

� Children are big business in today’s modern society. Parents are morethan willing to make sacrifices for their children. These sacrificesrepresent the opportunity cost of choosing to have children; the moneythat could have been spent on the best alternative if parents did nothave children.

� Knowledge of opportunity cost, even if it cannot be calculated precisely,allows decision makers to gain better insight into the real costs of theirchoices and not just their monetary costs.

1. Investigate the importance ofindifference curves and budgetlines in consumer preferencetheory, and relate them toopportunity cost.

2. The Office of Health Economicshas a schools website entitled:The Economics of Health Care(www.oheschools.org). Using thesite research the importance ofopportunity cost in health careand how quality adjusted life years (QALYs) can be used by healthprofessionals to make decisions on treatment.

with Chief Examiner,Robert Nutter

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