Introduction

Choosing one possible use means sacrificing other possible uses.

When buying a horse, one should always take the time to look at its teeth. Teeth tell a lot about the health and age of a horse. In this post, however, we’re going to look at the rump of this horse. When an economic actor takes an action, he should look at the alternatives — sort of like looking at the rear of the horse.

Every voluntary transaction involves giving something you value less than what you receive. But this applies only to values in that instant. It doesn’t involve exchanges made at a different time and in a different place. The consumer must always keep in mind that when they exchange money for one good, they could be giving up many other goods.

Let’s slow down long enough to consider some of those alternatives.

Alternatives

“The economic actor takes into account alternative possible applications; choosing one possible use means sacrificing other possible uses.”

When a person purchases a good in the market, either with money or direct exchange of another good, what cost does that person incur?

Hint: not the money or item given in exchange.

The cost incurred includes all the items that could be exchanged for that same money or item. The specific cost is the next-highest item on the buyer’s preference scale.

Incurring costs plays an important role in individual decisions about resource allocation. Opportunity costs ensure that consumers always choose their most preferred item.

When opportunity costs decrease in one way or another, consumers will naturally demand more goods than they otherwise would.

Recognizing opportunity costs tells individuals what alternatives they must give up to complete an exchange.

Conclusion

Including opportunity costs does not negate the subjective value theory; it simply expands the range of goods considered.

Does the purchase of an exciting video game in the present have more value than paying for a college education in the future?

Consumers should remember that price gives objective evidence of what they value in the present, but cost—known only to the consumer—signals value across space and time.

With every purchase consumer should hesitate for a moment to consider the opportunity cost of every transaction.