This is intimately linked with the concept of ‘trade-offs‘, because trade-offs create opportunity costs.
A trade-off is defined as “An exchange of one thing in return for another, especially relinquishment of one benefit for another regarded as more desirable.”
Suppose I have 1000 units of currency with which to purchase clothes. I can spend it on either a single expensive suit from a premium brand, or two shirts and one pair of trousers from a budget brand.
The suit is a little tight at the waist, but I figure I can always lose the weight, and buy it.
Two years later, I still haven’t lost enough weight to properly fit the suit. In the meantime, I’ve had to regularly dry-clean the suit to maintain its pristine look (shop recommendation), costing me an additional 100 units of currency.
What was the trade-off here?
The trade-off was the pair of shirts and trousers that I did not purchase.
What was the ‘Opportunity cost’?
The cost of not purchasing the pair of shirts and trousers. Since the monetary cost of the suit was equal to that of the shirts and trousers, the opportunity cost was 1000 units of currency at the time. The opportunity cost after two years is 1100 units of currency. [If I had purchased the shirts and trousers in the first place, there would have been no need for dry-cleaning. Hence, the cost of dry-cleaning is added to the cost of the suit.]
If I had spent the same amount to obtain a ticket to the final of the cricket World cup in 2011, things could have been different.
At the time, tickets for the general public were in massive short supply. People were paying 5-6 figure amounts to get a ticket. I could have either used the ticket myself, or sold it to another for about 1,00,000 units of currency.
If I chose to watch ‘history being made’, my opportunity cost would not have been the 1000 units that I actually paid for the ticket, but the 1,00,000 units that could have been mine if I’d sold it.