Opportunity cost is a key concept in economics (Buchanan, 1987; Crowards, 1998). The opportunity cost is the net benefit forgone, because the resource providing the service can no longer be used in its next-most-beneficial use. As an example, suppose a farmer cuts down a forest to expand his cropland. If the consequent loss of timber, firewood and water purification function is the next best use of the land, then the value of timber, firewood and water purification is the opportunity cost of the expanded cropland. If someone chooses to spend time resting rather than food gardening, the opportunity cost is the food that might have been produced. Time is here the scarce resource; using it to rest entails a clear loss of opportunity for producing food. Thus, opportunity costs are not restricted to monetary or financial costs.
Uses
The opportunity cost approach is a very useful technique when benefits of certain uses, such as preservation, protection of habitats, cultural or historical sites, cannot be directly evaluated. For example, in the Yasuni ITT proposal in Ecuador in 2007, the government was ready to forego the revenue from the extraction of 850 million barrels of oil (taking into account the benefits from conservation of biodiversity, the rights on the indigenous population, and the carbon dioxide emissions avoided), but the government asked for external contributions from other countries to cover half the ‘opportunity cost’ (that is, half the foregone revenues that would be obtained by extracting and selling the oil).
Issues
The concept of opportunity cost is at the heart of a debate on economic growth between standard (environmental) economics and ecological economics in the way they see the world. While the former sees the economy as the whole, drawing from nature or the environment as sectors of the macro-economy (forests, fisheries, grassland, mines, wells, eco-tourist sites and so on), the latter envisions the (macro) economy as a part of a whole, namely the earth, its ecosystems and its atmosphere, within a finite, non-growing and materially closed ecosystem.
Starting from this point, if the economy grew in a void, it would encroach on nothing and its growth would have no opportunity cost so that it could expand without limit. However, since the economy grows into a finite ecosystem, the growth of the macro-economy overlaps onto the non-growing whole, implying a sacrifice of something (the opportunity cost). Thus, growth does have a cost and at some point, the continued growth of the macro-economy will cost us more than it is worth. This is what is referred to by Daly (2007) as ‘uneconomic growth’. In a situation where the economy was very small relative to the ecosystem (as in pre-industrial times), there would be no need to stop growing since resources would be abundant and the opportunity cost for economic expansion would be insignificant. Nevertheless, in the long run, with continued growth, we would arrive at a state in which the opportunity cost of growth was significant.
References
Buchanan, J.M. (1987) ‘Opportunity cost’, in The New Palgrave: A Dictionary of Economics, vol. 3, Basingstoke: Palgrave-Macmillan.
Crowards , T.M. ( 1998 ) ‘Safe minimum standards: costs and opportunities’, Ecological Economics, 25 ( 3 ): 303 – 314.
Daly, H.E. (2007) Ecological Economics and Sustainable Development, Selected Essays of Herman Daly, Northampton, MA: Edward Elgar.
This glossary entry is based on a contribution by Alexis Gérard
EJOLT glossary editors: Hali Healy, Sylvia Lorek and Beatriz Rodríguez-Labajos
