Nov. 5, 2014
Opportunity cost sounds ominous. Like you are really going to be missing out or possibly making a big mistake if you choose wrong. Without realizing it, we make minor decisions in our lifestyle choices that involve calculating opportunity cost. Opportunity cost is basically considering what you can’t do as the result of each possible decision you make. Don’t worry. We are here to teach you how to calculate opportunity cost and how it works so you always make the best decisions. Our professor on the show today is Dan Egan from Betterment and he’s drinking beer brewed at Betterment! What is Opportunity Cost? Opportunity cost is what you give up when you choose between options. No matter what we choose, there is a next best choice that we give up or an opportunity forgone, that is the opportunity cost. We want to minimize our opportunity cost by choosing the option that benefits the most. Considering that almost every decision you make has a potentially beneficial alternative, you will never be able to eliminate opportunity cost entirely. The important thing is not to brood over “what ifs” and “should haves”. Rather be pragmatic and responsible each time you are decision making. “One of the most important concepts of economics is ‘opportunity cost’ – the idea that once you spend your money on something, you can’t spend it again on something else.” Malcolm Turnbull Decision making typically involves constraints such as time, resources and rules – risk vs reward, cost vs quality, salary vs quality of life. Opportunity cost is considering what you can’t do as the result of each possible decision. Opportunity Cost = Return of Most Lucrative Option – Return of Chosen Option Scarcity We have to weigh opportunity costs because of scarcity. Scarcity means limited resources. All of our resources, time, money, effort, are not infinite and could be used in a variety of ways. You may be able to allocate the time you spend earning a new certification or degree into advancing within your current position, for example. In this situation, you would have to decide what the most valuable allotment of your time is and what would have the greatest potential for the greater return on your chosen investment. So we have to carefully consider our decisions to make sure what we are gaining by making one choice over another is more valuable than what we are foregoing. Simple Examples of Opportunity Cost Even simply deciding where you want to eat comes with unavoidable missed opportunities. You want to go out to dinner. You decide to go to the French place over the Italian place. The enjoyment of an Italian meal is the opportunity cost of that decision. Although you might thoroughly enjoy your meal at the French restaurant, even more so than you would have at the Italian place, you will still have missed out on the good food and enjoyable experience. And the baguettes. Oh, the baguettes! Opportunity cost can apply to your everyday purchases, as well. You want Netflix for the month and a new book. You don’t have money for both. You choose the book. Watching Netflix is the opportunity cost. Investing Examples Of course, there are situations where the opportunity cost of a decision is much higher than eating steak tartar instead of pasta. Choosing an investment vehicle is one area where opportunity costs must be more carefully considered. Any time you invest your money in the stock market, there are certain trade-offs that you must expect. Learn more about your ad choices. Visit megaphone.fm/adchoices
