Understanding Tradeoffs and Opportunity Cost in Microeconomics

Perhaps one of the most fundamental principles of Microeconomics is that people face tradeoffs. According to Mankiw, “making decisions requires trading of one goal against another.” This situation of facing tradeoffs stems from the concept of scarcity - which in essence is limited resources - forcing one to make decisions and tradeoffs between several options. A concept well associated with this is opportunity cost - which is defined as how much one has to give up (the cost) in order to get the good or service (generally the alternative desired or wanted). Opportunity cost is also commonly defined as “the value of the next best alternative in a decision.” This concept of opportunity cost may be difficult to grasp as a bare definition but applying it to a situation may simplify and clarify the concept allowing a more universal understanding of it. To better our understanding of this concept, let us analyze the following scenario and assess the opportunity cost associated with it.

Assume that I have $150 to see a concert - either seeing “Hot Stuff” or “Good Times Band.” Both concerts cost $150 for a ticket but you I the “Hot Stuff” concert more at $225, while accessing the value of “Good Times Band” at $150 - the same

First, there is a monetary value that is significant in this hypothetical situation. Simplying looking at the cost of a ticket to either concert, there is no difference as both tickets cost $150. But by personally valuing “Hot Stuff” at $225 and “Good Times” at $150, there is a $75 difference between the two valuations. In plain monetary terms, the cost of going to “Hot Stuff” is $75 more than going to “Good Times” considering your personal valuation. While most people would probably assume watching the higher valued option at the same price (for a ticket) should be chosen, there are many other costs associated with going to either