Choosing the right OPPORTUNITY cost

Opportunity cost is the loss of potential gains in choosing one path or opportunity over another. Opportunity cost is really just a fancy economic term for a trade-off. Since every resource (time, money, knowledge, etc.) can be put to alternative use, every choice has an intrinsic opportunity cost/trade-off. Opportunity cost is measured by comparing the cost of what you are gaining versus what you are giving up to receive what you earned.

Alternative 1 (what's gained) - Alternative 2 (what's foregone) = Opportunity cost

Some trade-offs can be estimated based on extrinsic factors such as money spent, while others can be measured by intrinsic factors such as time lost. Both will be discussed in the following paragraphs.

Example 1 - Intrinsic opportunity cost

If you spend time going to the movies, you cannot use that same time to meditate. For this example, let's say meditation is your best alternative to going to the movies. The opportunity cost of going to the movies is the solitude you forgo by not meditating.

Another great example relates to career paths. If you enjoy teaching you shouldn't become an engineer instead of a professor simply because engineers earn more money than professors. In choosing to be an engineer, you would be trading years of your happiness for money. Intrinsic opportunity costs are even more important than money because they, in most cases, determine our joy, peace, enjoyment, longevity, etc.

Example 2 - Extrinsic opportunity cost

Sally is a working professional and needs to eat lunch while at work. She has two options for lunch. If she buys lunch every day, the trade-off would be making her lunch. On average, it costs her $7 to prepare her lunch and $15 to buy lunch every day. The opportunity cost of buying lunch would be $8 ($15 to buy lunch - $7 to make lunch = $8). If Sally buys lunch five days per week, this would equal $40 per week, or $160 per month, or $1,920 per year. She is spending $1,920 more per year than she would be spending by making her lunch. When we begin to look at these decisions on a yearly basis, it gives a better longterm impression than if we were to assess it on a daily basis. The "simple" decisions that we make which cause us to spend an extra dollar here or there adds up and could most certainly have been used for accomplishing other asset generating goals.

Bottom line

The world that we live in is predicated on the construct of time, so it is not possible to be in two places at once or execute two completely different actions simultaneously. We can't both run and walk at the same time. We can't eat out and sleep in at the same time. Theses are not possible because we are limited by time and space. When assessing opportunity costs, be sure not to overthink every decision. Should I have gone to school? What would my life have been like had I not gotten married? You'll drive yourself crazy doing that! Focus on the present and future decisions that are controllable and make wise decisions. Be sure to prioritize based on your goals.

1 view0 comments

Recent Posts

See All