Imagine you work at the local ice cream shop. You’ve got a night shift for 5 hours, which at your going rate of $10/hour, would result in $50 of income.
However… your crush on wants to go to the movies with you tonight. The movie tickets are going to cost you $20.
At first glance, you might think skipping out on work and going to the movies is just going to cost you $20 for the tickets. However… There's another cost not being considered here.
Opportunity cost is the loss of potential gain from other alternatives (ex: going to work) when one alternative (ex: going to the movies) is chosen.
Let’s start with the formula for opportunity cost, and then break it down from there:
Opportunity Cost = Explicit Cost + Implicit Cost
Opportunity Cost = Explicit Cost + Implicit Cost
Opportunity Cost = $20 + Implicit Cost
Opportunity Cost = Explicit Cost + Implicit Cost
Opportunity Cost = $20 + $50
Opportunity Cost = Explicit Cost + Implicit Cost
Opportunity Cost = $20 + $50
Opportunity Cost = $70
As humans, we typically focus on the accounting cost (explicit only)...
Accounting cost is the explicit cost of an activity.
...when in fact we should be focused on the economic cost (explicit + implicit)...
Economic cost is the accounting + opportunity cost. In other words, the explicit + implicit costs.
...as this represents the true cost of something.