Alternative Cost

What is an Alternative Cost?

Definition: An alternative cost is a potential benefit that could have been received but wasn’t because another course of action was taken.

What Does Alternative Cost Mean?

Often alternative costs are considered the lost benefits associated with the choices not made. An individual usually takes these into account when making decisions regarding the use of their time, money, and the utility an action or good provides. The option chosen reflects a greater value to the decision-maker which can be attributed to many reasons and circumstances.

An alternative cost is a benefit, profit, or value of something that must be given up to acquire or achieve something else. Since every resource (land, money, time, etc.) can be put to alternative uses, every action, choice, or decision has an associated alternative cost.

Alternative costs are fundamental costs in economics, and are used in computing cost benefit analysis of a project. Such costs, however, are not recorded in the account books but are recognized in decision making by computing the cash outlays and their resulting profit or loss.

Example

For example, let’s assume you have $15,000 that you could either invest in Company XYZ stock or put toward a graduate degree. You choose the stock. The alternative cost in this situation is the increased lifetime earnings that may have resulted from getting the graduate degree – that is, you choose to forgo the increase in earnings when you use the money to buy stock instead.

Here’s another example. Let’s say you have $15,000 and your choice is to either buy shares of Company XYZ or leave the money in a CD that earns only 5% per year. If the Company XYZ stock returns 10%, you’ve benefited from your decision because the alternative would have been less profitable. However, if Company XYZ returns 2% when you could have had 5% from the CD, then your opportunity cost is (5% – 2% = 3%).

Summary Definition

Define Alternative Costs:

  • cost that would pertain if an alternative set of conditions or assumptions were to prevail (as compared to a cost assumed or experienced under current conditions).
  • choosing the next best or highest valued alternative, compared to the chosen alternative, will result in benefits forfeited, and thus an alternative cost.

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