Opportunity Cost is what you must give up in order to do something else. Marginal Cost is what producing one more unit actually costs out-of-pocket. In the decision making process, the Marginal Cost is weighed against the Opportunity Cost to determine the Actual Cost Value of doing something-which is called the Cost Benefit Analysis.
In terms of education, the Marginal Cost is the actual tuition and the Opportunity Cost is what the student would have made had he or she worked a full time job in that same amount of time. The tuition may be $30,000 for that year but the student would have made $20,000 had he or she worked a full time job. So the actual cost of the tuition is $50,000-not $30,000. The total amount is the actual investment being made into the student’s education. Even if a student gets a full ride scholarship, he or she still makes the Opportunity Cost investment into his or her own education-which in this case would be $20,000 per year. Four years at $20,000 adds up to $80,000. This can help to determine whether the investment is worth it or not.
Sometimes Opportunity Costs increase. Increasing Opportunity Cost does not show up on every model though. Opportunity Costs cannot be used for business expenses on things like taxes-this is strictly an economic concept that is used in decision making. Marginal Cost can also increase. Marginal Cost can be used for business expenses on things like taxes because Marginal Costs are actual out-of-pocket expenses.
Opportunity Costs increase because the more units you produce cause you to give up more and more of the alternative. Sometimes the Law of Diminishing Returns is a factor in the increased Opportunity Cost as well as the increased Marginal Cost. Say you have an acre of land and 50 barrels of raw crude was discovered on your property. Suppose there is another 20 barrels of crude in the sediment and you can get another 10 barrels from fracking. All together you can extract 80 barrels of raw crude that you can sell for $2.00 per barrel profit. Suppose that on the same land you have 80 barrels of ground water that you can sell for $1.00 profit on the market for drinking water.
In this analogy, the first 50 barrels of crude is a no brainer because it does not cost you any water to extract the crude. Thus, if you limit your production to only the 50 barrels, you can extract both the water and the crude oil for a total profit of $3.00 per barrel per space. In order to extract the remaining 30 barrels of crude, you will need to use some of your water in the process. Say for the next 20 barrels, you will need to use 1 barrel of water for every two barrels of crude you extract. Then, for the last 10 barrels of crude you will need to use 3 barrels of water to extract one barrel of crude.
In your Cost Benefits Analysis, you need to figure out exactly how much water it is worth to extract the crude oil. If you are using the crude oil in terms of water-the water is your Opportunity Cost. If you are using the water extracted in terms of crude oil, then the crude oil is your Opportunity Cost.
So, in this example, the first 50 barrels of crude oil does not cost any water (although it does cost real estate and time as an Opportunity Cost because you could always build a house on that property and rent it out-or grow a farm and sell the veggies. For simplicity sake we will keep it only in terms of crude oil and water). The first 50 barrels can be attained without the Opportunity Cost in terms of water, so it is beneficial to produce at least 50 barrels because you could ideally produce both the water and the crude oil and profit from both.
The next 20 barrels will require some figuring: for every 2 barrels of crude it will require 1 barrel of water. The profit from 2 barrels of crude will be $4.00. The profit from 1 barrel of water is $1.00. Thus your profit is reduced to $3.00 because of the Opportunity Cost in terms of the water (You must use the water instead of sell it on the market). So, all together, for 20 barrels of crude you will lose 10 barrels of water. This might still be worth it.
Down to the last 10 barrels of crude: it will cost you 3 barrels of water to extract 1 barrel of crude. You will make $2.00 profit on the crude but it will cost you $3.00 in profit loss from the water. In this event, it may not be such a good idea to continue fracking because it is actually costing you more to produce it than you are making.
That’s how Opportunity Cost and Marginal Cost works.
Khan Academy-Opportunity Cost
Business Dictionary-Opportunity Cost
Library of Economics-Opportunity Cost
Khan Academy-Increasing Opportunity Cost
Khan Academy-Allocative Efficiency and Marginal Benefit