Questions: Opportunity Cost and Economic Decision-Making

Question 1

A business owner uses her own building for her business instead of renting it out at $2,000/month. Her accountant reports zero rent expense. What does an economist conclude?

• A. The economist agrees — no cash outflow means no economic cost
• B. The economist recognizes a $2,000/month opportunity cost, even though no cash changes hands
• C. The business is earning $2,000/month in hidden economic profit from the building
• D. Opportunity cost only applies when the alternative is selling an asset, not renting it

Answer: (B)

Opportunity cost includes implicit costs — value foregone even without any cash transaction. By using the building herself, the owner gives up $2,000/month she could have earned. That foregone rent is a real economic cost. Accounting profit subtracts only explicit cash outlays; economic profit subtracts all opportunity costs including implicit ones. A business earning exactly its accounting costs may actually be earning negative economic profit once implicit costs are included.

Question 2

You paid $150 for a non-refundable concert ticket, but you're sick on the day of the show. Your friend says you have to go because you already paid $150. What error is your friend making?

• A. No error — the $150 is an opportunity cost of not going, so it should affect the decision
• B. The friend is treating a sunk cost as if it should influence a future decision, but the $150 is gone whether you go or not
• C. The friend is making an accounting error — the $150 should be recorded as a future expense
• D. The friend is correctly applying opportunity cost: going 'recovers' the $150

Answer: (B)

The $150 is a sunk cost — already spent and unrecoverable regardless of what you decide. Rational decision-making is forward-looking: the only relevant costs are the opportunity costs of your remaining choices. Going means spending an evening feeling sick; staying home means rest. The $150 doesn't factor in because it doesn't change. The 'have to get your money's worth' reasoning is the sunk cost fallacy — letting past costs distort future decisions.

Question 3

The opportunity cost of choosing an action is the total value of most of the alternatives you gave up.

• T. True
• F. False

Answer: False

Opportunity cost is the value of the single best alternative foregone — not the sum of all alternatives. If you have options A, B, and C and choose A, your opportunity cost is whichever of B or C you valued more highly, not both combined. Summing all foregone alternatives would systematically overstate the cost. The 'best foregone alternative' definition is what makes opportunity cost the true economic cost: it captures the most you actually sacrificed.

Question 4

A worker earning $50,000/year who could earn $70,000 elsewhere faces a $20,000 opportunity cost even though she receives a paycheck every month.

• T. True
• F. False

Answer: True

Opportunity cost captures foregone value even when money is flowing in. The $70,000 alternative is what she gives up by staying in her current job. The $20,000 gap between actual and forgone earnings is a real economic cost — it doesn't appear in any bank account, but it represents real value sacrificed every year. This is why economic analysis often reaches different conclusions than accounting: implicit costs like this one are invisible to accountants but fully real to economists.

Question 5

Why should sunk costs be ignored in future decision-making, while implicit opportunity costs must be included — even though neither involves a cash payment at the time of decision?

Model answer: Sunk costs are already spent and unrecoverable — the $150 concert ticket is gone whether you attend or not, so it cannot change based on your choice. Including it in your reasoning (the sunk cost fallacy) leads to decisions based on past losses rather than future value. Implicit opportunity costs, by contrast, are future-oriented: they represent real value you will or won't receive depending on your choice. The building owner who ignores the $2,000 forgone rent is systematically underestimating what it costs to run her business. Rational decision-making requires including all future consequences of each option (including implicit ones) while excluding all past costs that can't be recovered.

The common thread is that only future, changeable costs and benefits should drive decisions. Sunk costs can't change based on your choice; implicit opportunity costs can. The 'sunk vs. opportunity' distinction is ultimately a distinction between costs that are already determined and costs that are still contingent on what you decide next.