Can Opportunity Cost Be Negative

can opportunity cost be negative

It was recently asked of me whether an opportunity cost could be negative. The consensus around me seemed to indicate that of course it could be, and even an accounting text book said so. So of course they have to be right. My initial thoughts were though, that an opportunity cost of course could not be negative. As a logical question though, it has to have a logical answer. So, can opportunity cost be negative?

 

An opportunity cost is defined as the foregone benefits from choosing one decision over another. The cliche, though classic, example is of a young adult deciding whether to study or to go party. If he parties, the opportunity cost is the benefits he would have obtained from instead studying. That would include the direct result of a higher grade, the money saved from not driving to the party and spending time driving, the health consequences of avoided had he not drank all that alcohol and so forth. Had the student instead chose to study over partying, the opportunity cost is the lost benefits that would have been gained had he chosen to study instead, such as : creating good memories, the time spent with friends, socializing, relaxing during a stressful exam period… and so on.

 

Both of those situations provide utility to the student and thus provide a positive opportunity cost. For an opportunity cost to ever “be negative” a situation would have to exist where negative utility would exist. The literal definition of an opportunity cost though, is the benefits foregone, not the cost foregone. Therefore, if a benefit is not provided in all alternative options, an opportunity cost is not presented.

 

Let us though for the sake of the argument and further discussion assume that ‘negative benefits’ is allowable, and that the definition is not to be taken literally. Once again, can opportunity cost be negative? Consider the following economic facts. Conceptually, diminishing marginal utility can lead to negative utility when additional units are consumed past a certain point. In practical senses though and in reality, the nth unit that  provides negative utility is never considered. It is a staple of neoclassical economic thinking that all decision making entities act in their self-interest and are logical as to choose only decisions where benefits > costs. So when creating a table or in discussion we can say “conceptually the nth unit will lead to negative utility”, however in reality and for practical purposes that just isn’t so. When the nth unit is obtained that provided 0 utility, no additional  units are consumed. So in a literal sense, negative utility cannot be obtained via declining marginal utility.

 

can opportunity cost be negative

can opportunity cost be negative

 

Applying the same concept to opportunity cost explains the question of “can opportunity cost be negative?” As decision makers, any action that leads to negative utility is never considered. If it is not considered it cannot be foregone and thus cannot be measured as an opportunity cost. Therefore the answer is, opportunity cost cannot be negative.

 

Many individuals that analyze this question assume they can disregard definitions and the assumptions that make  up there very model in which the term opportunity cost is derived from. That is an inconsistent way of thinking however. It would be more appropriate to state however that while an opportunity cost appears to exist when measured/analyzed, but upon choosing one decision it is revealed that the outcome is negative utility. Perceived utility does not always  match the actual outcome due to information asymmetry and impacting variables that may deviate from the expected values. In that case though, it would no longer be presented as an opportunity cost and would better be referred to as simply a cost incurred.

 Opportunity Cost Cannot be Negative

In short though. An opportunity cost cannot be negative.

 

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