Opportunity cost
The value of the best alternative given up by a choice. For a country, it is the other goods its resources could have produced instead, and it is what comparative advantage compares.
Where you will meet it
Opportunity cost appears in 6 learning outcomes on the CFA syllabus. A few of them:
- Set out frequent mistakes in capital allocation and explain real options
“The recurring pitfalls are behavioural rather than technical: including sunk costs, ignoring the opportunity cost of assets the project will consume, overlooking cannibalisation of existing products, and internal politics that favour the most persuasive sponsor rather than the best project.”
- Set out the gains from international trade and what it costs
“Trade allows countries to specialise where they have a comparative advantage — the lowest opportunity cost, not necessarily the lowest absolute cost — which raises total output and lowers prices.”
- Explain how the cost of a trade is measured and work out that cost
“It splits into delay cost (arrival price − decision price, on shares traded), execution cost (execution price − arrival price, on shares traded), opportunity cost (final or cancellation price − decision price, on shares never traded) and explicit fees.”
- Explain what makes up the cost of executing a trade, both visible and hidden
“Large or urgent orders in illiquid securities tend to have high implicit costs, and there is a trade-off: trading quickly raises market impact, whereas trading slowly raises delay and opportunity cost.”
See also
Practise it
Practise opportunity cost until it is automatic: questions that explain every wrong option.
Take the free diagnostic →