why is the concept of opportunity cost important
Opportunity cost In microeconomic theory, the opportunity cost, also known as alternative cost, is the value (not a benefit) of the choice of a best alternative cost while making a decision. A choice needs to be made between several mutually exclusive alternatives; assuming the best choice is made, it is the "cost" incurred by not enjoying the benefit that would have been had by taking the second best available choice.[1] The New Oxford American Dictionary defines it as "the loss of potential gain from other alternatives when one alternative is chosen." Opportunity cost is a key concept in economics, and has been described as expressing "the basic relationship between scarcity and choice."[2] The notion of opportunity cost plays a crucial part in attempts to ensure that scarce resources are used efficiently.[3] Thus, opportunity costs are not restricted to monetary or financial costs: the real cost of output forgone, lost time, pleasure or any other benefit that provides utility should also be considered an opportunity cost.
Cost–benefit analysis Cost–benefit analysis is often used by organizations to appraise the desirability of a given policy. It is an analysis of the expected balance of benefits and costs, including an account of foregone alternatives and the status quo. CBA helps predict whether the benefits of a policy outweigh its costs, and by how much relative to other alternatives, so that one can rank alternate policies in terms of the cost–benefit ratio.[3] Generally, accurate cost–benefit analysis identifies choices that increase welfare from a utilitarian perspective. Assuming an accurate CBA, changing the status quo by implementing the alternative with the lowest cost–benefit ratio can improve Pareto efficiency.[4] While CBA can offer a well-educated estimate of the best alternative – perfect appraisal of all present and future costs and benefits is difficult –, perfection in terms of economic efficiency and social welfare are not guaranteed.[5]