Real-Life Examples of Opportunity Cost

How do economists view everyday financial decisions? Through a lens of trade-offs and the next best alternative.

When you’re at the mall choosing between a strawberry smoothie and a kiwi smoothie—or any other alternatives—you're encountering a key economic concept: opportunity cost.

How is opportunity cost defined in everyday life? “Opportunity cost is the value of the next-best alternative when a decision is made; it's what is given up,” explains Andrea Caceres-Santamaria, senior economic education specialist at the St. Louis Fed, in her well-read Page One Economics essay: “Money and Missed Opportunities.”

The Economics of Scarcity: Why Opportunity Cost Matters

We can’t have everything we want in life. We face a fundamental economic conflict: unlimited wants and needs versus limited resources. Our desires for goods, services and experiences constantly exceed our available:

• Time
• Money
• Opportunities
• Resources

This scarcity drives every economic decision we make, creating trade-offs and costs with each choice, Caceres-Santamaria says. Consider that simple decision about buying a $7 smoothie at the mall. Many people would view this as a yes-or-no choice based on desire alone. Instead, Caceres-Santamaria suggests putting on “economist glasses” to see the decision differently, asking:

1. How much do I value this?
2. What am I giving up now to have this?
3. What am I giving up in the future to have this now?

Every Decision Involves Trade-offs

Inspired by Andrea Caceres-Santamaria, “Money and Missed Opportunities.” Page One Economics, October 2019. Icons by Getty Images.

■ FEDERAL RESERVE BANK OF ST. LOUIS

Understanding Types of Opportunity Cost: Explicit vs. Implicit

Our inclination is to focus on immediate financial trade-offs, but trade-offs can involve other areas of personal or professional well-being as well—in the short and long run.

Explicit costs are immediately obvious financial trade-offs present at the time of decision-making. These are the alternatives you can clearly see and measure.

Implicit costs are “unseen” opportunity costs that extend beyond immediate financial considerations. As Caceres-Santamaria explains, “It's about thinking beyond the present and assessing alternative uses for the money—that is, not being shortsighted.”

These hidden costs can involve:

• Long-term financial opportunities
• Personal well-being
• Professional development
• Time and productivity
• Future earnings potential

Real-Life Opportunity Cost Examples

Example 1: Student Learning vs. Leisure Choices

Scenario: A student spends 3 hours and $20 at the movies the night before an exam.

The opportunity costs include:

• Lost study time that could improve grades
• $20 that could be saved or spent on educational materials
• Potential impact on exam performance and future academic opportunities

Example 2: Agricultural Decision-Making

Scenario: A farmer decides to plant wheat.

The opportunity cost represents:

• Alternative crops the farmer could have planted (corn, soybeans, etc.)
• Different uses for land and farm equipment
• Potential profit differences between crop choices
• Market timing and price considerations

Example 3: Commuting Options and Time Value

Scenario: A commuter chooses to take the train (70 minutes) instead of driving (40 minutes).

Opportunity cost calculation:

• 30 additional minutes per commute
• Approximately 1 hour daily (round trip)
• Five-plus hours weekly that could be spent elsewhere

Potential benefits offsetting this cost:

• Lower stress levels
• Ability to work or read during transit
• Reduced vehicle wear and fuel costs
• Environmental considerations

Opportunity Cost in Major Financial Decisions

We might not consider lost studying time or $7 spent on a smoothie to be costly decisions, but what about bigger choices—like the decision to stretch and buy a more expensive home versus a starter home, or to spend $1,500 more on an upgraded trim package for your next car?

Caceres-Santamaria describes how opportunity costs are neglected even more when making higher priced purchases. We tend to evaluate costs relative to the total purchase price rather than weigh the added costs in absolute terms.

Car Buying Example: The Upgrade Decision

Scenario: Choosing a $1,500 upgrade package on an $18,500 car.

Common thinking: “It's only 8% more than the base price.”

Opportunity cost thinking: “What else could that $1,500 buy outright?”

Alternative uses for $1,500 could be:

• Emergency fund contribution
• Retirement account investment
• Debt reduction
• Educational courses
• Home improvements

Similarly, choosing a more expensive home over a starter home involves significant opportunity costs, such as:

• Reduced investment capital
• Less financial flexibility
• Lost equity growth in alternative investments

The Psychology behind Windfalls and Found Money

Caceres-Santamaria explains in a more recent Page One Economics essay how mental accounting—the tendency to assign different categories and values to money, rather than treat all money as having the same value—shapes our financial choices.

In this related video short from our Economic Education team, learn how our brains sort money into groupings—from gifts to paychecks—even though money is interchangeable.

Opportunity Cost and the Future Value of Money

“Most of our decisionmaking that involves money is based on immediate or sooner-than-later consumption,” Caceres-Santamaria notes in her “Money and Missed Opportunities” Page One Economics essay. “The excitement of consuming today is valued significantly more than the thought of consuming in the future.”

It’s human nature: We grow impatient, tugged by the immediacy of a promised benefit versus a payoff that’s possibly years down the road.

If seeing is believing, it’s worth looking at the future value of money—a concept many of us have read about in retirement saving guides or heard from financial experts.

Let’s look at two examples of the impact of opportunity cost on the future value of money. (Note that these examples don’t factor in the impact of inflation and taxes.)

Example 1: The One-time Windfall

Let’s say you got a surprise $4,000 windfall and want to use it for a getaway trip. Why not? It’s found money, so there’s no loss to you—unless you think about the opportunity cost.

If, instead of a trip, you invested that money in an income-producing product that earned an average annual interest rate of 3%, compounded monthly, you could find yourself with $5,397—your $4,000 windfall plus $1,397 in earnings—in 10 years, as the chart below illustrates.

Total Savings

NOTES: Chart is for illustrative purposes only. Created with Compound Interest Calculator on Investor.gov.

Wait another five years, and your funds could grow to $6,270, earning you an additional $2,270 over the original windfall. That’s the added benefit in money terms. You’ll also want to consider the experiences that an extra $1,400 or more—the future earnings on your $4,000—could make possible.

Example 2: Small, Regular Savings over Time

What about the opportunity cost associated with daily purchases, such as the $4.49 caffè mocha you pick up three times a week? How much money could you have if you invested that $54 each month rather than spending it?

If you dropped the coffee (careful!), invested the money and earned the same 3%, compounded monthly, you’d have $7,619 to dunk your doughnut into in 10 years. Too long to forego that regular mocha? Cutting the time frame in half to five years would still give you $3,554 in savings. (See the chart below for an illustration.)

Total Savings

NOTES: Chart is for illustrative purposes only. Created with Compound Interest Calculator on Investor.gov.

Did you notice? This seemingly small daily habit represents a larger opportunity cost than the $4,000 one-time vacation decision over the same period.

Applying Opportunity Cost Thinking to Your Financial Life

Opportunity cost can’t be predicted absolutely, but it can help you think through options and make decisions that improve your financial health.

Want to test some of your own opportunity cost what-ifs? Start with these simple steps drawn from the “Money and Missed Opportunities” essay:

1. Avoid Financial “Autopilot” Mode

Consciously consider spending decisions.

2. Ask Opportunity Cost Questions

For each potential purchase, practice asking:

• What else could this money buy?
• What would this money become if invested?
• What am I sacrificing in the future for this present benefit?

3. Start Small and Build the Habit

Begin with minor purchases such as a pack of gum to develop opportunity cost awareness.

4. Use Opportunity Cost Calculators

Test various “what-if” scenarios using online investment or compound interest calculators, budgeting apps or other financial resources you know and trust.

5. Consider Nonfinancial Opportunity Costs

Remember that opportunity costs extend beyond money. They can also be social and emotional.

Start today by choosing one regular expense and calculate its cost over five to 10 years. The results may surprise you. Your future self will thank you for the opportunity costs you consider today.

Editor’s Note: This post, originally published January 29, 2020, has been updated to include a video on mental accounting and more in-depth information.