Economists sometimes refer to this as the “there is no such thing as a free lunch” principle. Because resources are scarce, the use of resources to produce one good diverts those resources from the production of other goods. A parcel of undeveloped land could be used for a new hospital or a parking lot, or it could simply be left undeveloped. No option is free of cost-there is always a trade-off. The choice to pursue any one of these options means the others must be sacrificed. The highest valued alternative that must be sacrificed is the opportunity cost of the option chosen. For example, if you use one hour of your scarce time to study economics, you will have one hour less time to watch television, read magazines, sleep, work at a job, or study other subjects. Whichever one of these options you would have chosen had you not spent the hour studying economics is your highest valued option forgone. If you would have been sleeping, then the opportunity cost of this hour spent studying economics is a forgone hour of sleep. In economics, the opportunity cost of an action is the highest valued option given up when a choice is made.
It is important to recognize that the use of scarce resources to produce a good is always costly, regardless of who pays for the good or service produced. In many countries, various kinds of schooling are provided free of charge to students. However, provision of the schooling is not free to the community as a whole. The scarce resources used to produce the schooling-to construct the building, hire teachers, buy equipment, and so on-could have been used instead to produce more recreation, entertainment, housing, medical care, or other goods. The opportunity cost of the schooling is the highest valued option given up because the resources required for its production were instead used for schooling.
By now the central point should be obvious. As we make choices, we are continually faced with trade-offs. Using resources to do one thing leaves fewer resources to do another. Consider one final example. Mandatory air bags in automobiles save an estimated 400 lives each year. Economic thinking, however, forces us to ask ourselves if the $SO billion spent on air bags could have been used in a better way-perhaps say, for cancer research that could have saved more than 400 lives per year. Most people don’t like to think of air bags and cancer research as an “eitherlor” proposition. It’s more convenient to ignore these trade-offs. But if we want to get the most out of our resources, we have to consider all of our alternatives. In this case, the appropriate analysis is not lives saved with air bags versus dollars spent on them, but the number of lives that could have been saved (or other things that could have been accomplished) if the $SO billion had been used differently. A candid consideration of hard trade-offs like this is essential to using our resources wisely.