Opportunity Cost Formula, Calculation, and What It Can Tell You

Understanding the potential missed opportunities when a business or individual chooses one investment over another allows for better decision making. To understand opportunity cost in the business world, you need to know what economic profit is. Economic profit is the money that a business makes after deducting both implicit and explicit costs. The idea is that business needs to generate revenue over opportunity costs to grow and thrive.

Aside from the missed opportunity for better health, spending that $4.50 on a burger could add up to just over $52,000 in that time frame, assuming a very achievable 5% RoR. When feeling cautious about a purchase, for instance, many people will check the balance of their savings account before spending money. But they often won’t think about the things that they must give up when they make that spending decision. One of the accounts payable ledger most famous examples of opportunity cost is a 2010 exchange of Bitcoin for pizza. The opportunity cost of exchanging the 10,000 bitcoins for two large pizzas peaked at almost $700 million based on Bitcoin’s 2022 all-time high price. Conforming loans have maximum loan amounts that are set by the government and conform to other rules set by Fannie Mae or Freddie Mac, the companies that provide backing for conforming loans.

People Make Time For What They Want — And You Should Too

So the opportunity cost of buying an SUV includes an alternative option, such as buying a less expensive sedan. This opportunity cost calculator helps you find the value of the cash you want to spend on a non-investment product. Calculating the opportunity cost will also help you decide if the product is worth buying now, as well as learn to use the opportunity cost formula. A sunk cost is money already spent in the past, while opportunity cost is the potential returns not earned in the future on an investment because the capital was invested elsewhere. When considering opportunity cost, any sunk costs previously incurred are ignored unless there are specific variable outcomes related to those funds.

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The key to understanding how businesses see opportunity costs is to understand the concept of economic profit. For businesses, economic profit is the amount of money made after deducting both explicit and implicit costs. This idea is called opportunity cost, and it can help people and businesses make better financial choices. Opportunity cost is a term economists use to describe the relationship between what an item adds to your life, and how much it might cost you by not having it, taking into account your other options.

In the field of economics, opportunity cost is the value that you have to forgo when you choose an option over another good option. It is a concept you can apply in many situations, from deciding which projects you should pursue to spending time with loved ones instead of working overtime. Most people overlook opportunity costs because the benefits are usually hidden from view. This information is not intended as a recommendation to invest in any particular asset class or strategy or as a promise of future performance. There is no guarantee that any investment strategy will work under all market conditions or is suitable for all investors.

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Homeowners in some developments and townhome or condominium communities pay monthly Homeowner’s Association (HOA) fees to collectively pay for amenities, maintenance and some insurance. Zillow’s mortgage calculator gives you the opportunity to customize your mortgage details while making assumptions for fields you may not know quite yet. These autofill elements make the home loan calculator easy to use and can be updated at any point.

But without understanding opportunity cost, you would have no way of knowing that the taco purchases were, in fact, the best decision you could make. For this reason, opportunity cost is very important when it comes to business decisions. If you don’t calculate opportunity cost, you potentially miss out on all sorts of opportunities that could have led to greater business success.

Other Costs in Decision-Making: Incremental Costs

One formula to calculate opportunity costs could be the ratio of what you are sacrificing to what you are gaining. If we think about opportunity costs like this, then the formula is very straight forward. Consider the case of an investor who, at age 18, was encouraged by their parents to always put 100% of their disposable income into bonds. Over the next 50 years, this investor dutifully invested $5,000 per year in bonds, achieving an average annual return of 2.50% and retiring with a portfolio worth nearly $500,000. Although this result might seem impressive, it is less so when one considers the investor’s opportunity cost. Opportunity cost is used to calculate different types of company profit.