Calculating Opportunity Cost

Many times on an exam you will see questions that require you to calculate opportunity cost. The key to answering these questions is to focus on the cost of the choice. If someone loses the opportunity to earn money (implicit cost), that is part of the opportunity cost. If someone chooses to spend money (explicit cost), that money could be used to purchase other goods and services so the spent money is part of the opportunity cost as well. Add the value of the next best alternatives (the opportunities that would have been chosen had the choice not been available) and you have the total opportunity cost. If you miss work to go to a movie, your opportunity cost is the money you would have earned if you went to work plus the money spent to go to the movie. 

Note: In economics classes, the terms opportunity cost and cost are often used interchangeably. So when you hear cost, it is the implicit and explicit costs added together. 

Making Choices 

A basic assumption in Microeconomics is that people are generally rational. That means people tend to act in their own best interest. As a result, people only make a particular choice when the benefits outweigh the costs. Later you will learn most decisions are made incrementally at the margin. Other decisions cannot be broken down incrementally and must be made while looking at total benefits and total costs. If the total benefit of going to the movies is larger than the total cost (implicit and explicit), a rational person would go to the movies. That means if you choose to take work off to go see the next Avengers movie, you expect going to the movie will be worth more to you than the money you pent plus income you lost.

Note: For consumers, benefit is often called utility (the satisfaction that comes from consuming a good or service) and for businesses, benefit is often called revenue (the money brought in by selling a good or service).