Question

what is the formula for opportunity cost?

Answer 1

Dear magnoliabrownwilson

To answer the question about what is the formula for calculating the opportunity cost you have to consider first certain elements:

1. Define the set of alternatives A such that A is a set with at least two (2) elements.

A= (a1,...,an)

There is no opportunity cost if there is one (1) alternative.
The alternatives must be mutually exclusive.
You can only choose one and only one alternative

2. Define a set of valuation of the alternatives V(A) such that V is a set that contains the valuation of each alternative: V(A) ={v(a1),...,v(a2)}

The valuation of an alternative ai must contain the costs and benefits associated with the alternative. Assuming that the valuation can be expressed in monetary units:

v(ai)=b(ai) - c(ai)

Where b(ai) are the benefits of choosing alternative ai and c(ai) are the costs of of choosing alternative ai.

3. Using this elements the opportunity cost of choosing an alternative aj is equal to:

max = {v(a1),...,v(an)} where j≠1,..,n

Example (taken from [2]; see the bibliography used at the end):

You won a free ticket to see an Eric Clapton concert (which has no resale value). Bob Dylan is performing on the same night and is your next-best alternative activity. Tickets to see Dylan cost $40. On any given day, you would be willing to pay up to $50 to see Dylan. Assume there are no other costs of seeing either performer. Based on this information, what is the opportunity cost of seeing Eric Clapton?

A = {a1, a2} where a1=going to see Eric Clapton a2=going to see Bob Dylan

v(a2)=$50 - $40 = $10

Why? Because you are willing to pay up $50 to see Dylan but if you see Eric Clapton also holds that no cost is incurred in buying the ticket to see Dylan.

¿What is the opportunity cost of seeing Eric Clapton?

v(a2)=$10

Bibliography used

[1] James M. Buchanan (2008) “Opportunity cost”. From The New Palgrave Dictionary of Economics, Second Edition, 2008 Edited by Steven N. Durlauf and Lawrence E. Blume.

[2] Ferraro Paul J & Taylor Laura O, 2005. "Do Economists Recognize an Opportunity Cost When They See One? A Dismal Performance from the Dismal Science," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 4(1), pages 1-14, September.

[3] Colander, David. 2013. Microeconomics. 9 Edition. McGraw-Hill/Irwin, New York, NY

Best wishes

luifrancgom