You have an evening free. You could study for an exam, work a shift, or watch a movie. Whatever you choose, you give up the others. The value of the next best option is the opportunity cost. It is the hidden price of every decision, and economists consider it the true cost of anything.

Money costs are easy to see. Opportunity costs are not. A student who spends four years in college pays tuition, but also gives up four years of wages. That foregone income is part of the real cost of education. A company that uses its factory to make bicycles cannot use it to make motorcycles. The profit from the motorcycles is the opportunity cost of the bicycles.

The concept explains why sunk costs should be ignored. Money already spent is gone, regardless of what you do next. What matters is the value of the alternatives available now. A firm that keeps funding a failing project because it has already invested millions is falling for the sunk cost fallacy. The millions are irrelevant. Only the future matters, and the future is full of trade-offs.

Examples

• College: tuition plus foregone wages
• Factory: one product versus another
• Time: work versus leisure
• Capital: stocks versus bonds
• Land: farming versus development