Use These Applications of Opportunity Cost to Choose Better
Let’s say that I (hypothetically, of course) offer you two tickets to a concert of your favorite musical group completely free of charge – no strings attached!
What would be the cost to you? And what would you do?
“Wait, what?” you say. “I thought you just said they were free of charge?”
Before you answer, we first need to discuss the concept of opportunity cost and look at some examples of applications of opportunity cost.
What is Opportunity Cost?
Opportunity cost is a concept that comes from microeconomic theory. When making a choice, the opportunity cost is simply the value of the best alternative that was not chosen. In other words, it is what you are sacrificing or giving up by choosing what you choose.
According to Oxford Living Dictionaries, opportunity cost is:
“The loss of other alternatives when one alternative is chosen.
Idle cash balances represent an opportunity cost in terms of lost interest”
So, the opportunity cost of the money you are hiding under your mattress is the interest you are losing by not having it in an interest-bearing account or another type of investment.
Anytime we choose between two or more options, there are opportunity costs associated.
Let’s look at some applications of opportunity cost that we can all identify with in our own lives.
Applications of Opportunity Cost
There are many applications of opportunity costs in our lives, some examples being:
Taking a course in basket weaving during college means you are missing out on the popular “Rocks for jocks” course.
Being in a relationship with your significant other means you are bypassing opportunities to date others.
Going back to do your MBA may cost you $50,000 in tuition, it would also cost you in the salary you are forgoing to go back to school full-time.
The opportunity cost of sleeping in until 8 am instead of waking up at 6 to hit the gym is the great workout you are not taking part in.
Eating that greasy food now may mean not eating healthy and feeling good later.
Staying late at work means you won’t be able to go out with your friends which will result in your missing out on a good time. Going out with your friends may mean you will miss a deadline which carries its own consequences.
As you can see, there are many applications of opportunity cost which can affect your finances, time, relationships, health and many other areas of your life.
Why We Need to Consider Opportunity Costs
We cannot fully assess the quality of any option we are considering if we isolate it from its alternatives.
When making choices, not considering opportunity costs can lead us astray.
So, as you can see even decisions that seem like no-brainers involve the cost of the alternatives that are declined.
Advice for Thinking About Opportunity Costs
The standard advice from economists says you should only consider the next best alternative when making a decision based upon opportunity cost.
So, let’s say you and a friend are trying to figure out what to do on a Friday night, some options in order of mutual preference may be:
Country line dancing
Going to a strip joint
Having dinner in a great restaurant
Meeting for happy hour
Attending a basketball game
In terms of opportunity cost, going country line dancing will “cost” you whatever the cover charge is to get into the country bar, plus whatever you spend on drinks and food PLUS the opportunity cost of going to a strip joint (whatever that may be).
If you are listening to the advice from economists, this is where you will stop your “cost accounting”, you will not consider the rest of the options on the list.
This is also fantastic advice for everyday life when managing your own psychological reaction when having to make a choice. It is good practice to consider the next best alternative, but don’t waste time feeling bad about the other alternatives that you wouldn’t have chosen anyway.
But Here is the Problem…
It isn’t always easy because all of the options have potentially great features that you may like. For example, country line dancing may allow you to get some exercise, going to a strip joint may help you blow off some steam, having dinner in a great restaurant may be best for conversing with your friend, meeting for happy hour may help you relax and attending a basketball game may allow you to experience some excitement.
So, while you may have one favorite option, by choosing it you are passing up a bunch of other features or opportunities.
According to author Barry Schwartz in The Paradox of Choice: Why More is Less,
“If we assume that opportunity costs take away from the overall desirability of the most-preferred option and that we will feel the opportunity costs associated with many of the options we reject, then the more alternatives there are from which to choose, the greater our experience of the opportunity costs will be. And the greater our experience of the opportunity costs, the less satisfaction we will derive from our chosen alternative.” 1
Meaning, a greater array of choices will cause us to feel worse.
So, what do we do? How can we use opportunity cost to make decisions without feeling worse about what we choose?
Schwartz believes that we definitely need to consider different alternatives when making a choice. Failing to ignore opportunity costs may cause us to “overestimate” how great the best option really is.
He goes on to give…
4 Strategies to Use When Considering Opportunity Costs:
Other than only considering the next best alternative on the list, he also suggests:
(1) Sticking with what you always buy, that is unless you are legitimately dissatisfied.
(2) Not allowing yourself to be tempted by things that are “new and improved”.
(3) Unless there is an “itch”, don’t “scratch”!
(4) Not worrying about the fear of missing out on stuff if you do something. You will hear about it from your friends or through the media anyway.
Let’s Go Back to My Question from the Introduction…
I offered you 2 free tickets to a concert of your favorite musical group completely free of charge – no strings attached!
I then asked you what would be the cost to you and what would you do?
Now that you understand the concept of opportunity cost and have seen some applications of opportunity cost, how would you answer differently?
You now realize that they would not be free as there would be opportunity costs for you to consider.
Then you mentally consider a couple of opportunity costs:
The money you would get obtain by either scalping them or re-selling them on StubHub
Time that you could have spent binge-reading entertaining and actionable blog posts on Prime Your Pump etc. Or time doing whatever else you would be doing.
After carefully considering the opportunity cost you answer as follows:
“I’ll attend the concert, I have always wanted to see U2 live and attending beats the opportunity cost of selling the tickets for $500 each. And by the way (you say with a wink) I already subscribe to the Prime Your Pump weekly newsletter, so I have already read all of your entertaining and actionable blog posts.”
Touché reader, touché!
Until next time, keep thinking about different applications of opportunity cost and as always…PYMFP!
–Rick
Use it or Lose It
Other than only considering the next best alternative on the list, Schwartz also suggests:
(1) Sticking with what you always buy, that is unless you are legitimately dissatisfied.
(2) Not allowing yourself to be tempted by things that are “new and improved”.
(3) Unless there is an “itch”, don’t “scratch”!
(4) Not worrying about the fear of missing out on stuff if you do something.
When to Use It
When making choices in your life.
What Do You Think?
What do you think of these applications of opportunity cost? Do you use the concept of opportunity cost in your life?
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Interesting topic! Life presents us with daily choices and you have presented a helpful guide to aid us in making these choices. I agree that when there are too many options , decision making is more difficult. Thanks Rick
Hi Eileen, Yeah it is an interesting topic from the business world that can just as easily be applied to our personal lives. Thanks for reading and commenting and I agree, too many choices does make decision making more difficult! Be good, Rick
To my way of thinking, opportunity costs get factored in when considering alternative choices or suggestions. And the cost many times can be measured in something other than dollars and cents. Your example of free tickets reminds me of a similar situation. Way back when the 49ers were a playoff contender in 1996, a good friend at work offered me a pair of tickets to a playoff game at Candlestick, as she could not attend due to a prior commitment. Of course I grabbed the opportunity and said yes.
Game day it was pouring rain, so we donned our rain gear and took along a large piece of clear plastic to cover ourselves when seated. I normally detest rain, but this was one of those opportunities that presented itself. We stayed for the entire game, which the Niners won, plus it was George Siefert’s last win as the SF coach. Of course, we were drenched to the skin, but I never regretted going. Joan actually understood my rationale and didn’t give me any grief, other than her hair looked like absolute crap.
So what were the opportunity costs? The chance to watch the game cozed up on the couch with my blonde instead of driving the truck through the rain to the stadium, and us then sitting in the rain for 2 and a half hours. Saving the cost of gas and parking. Missing the chance to see a playoff game in person, the only one I’ve ever attended. So was the experience worth it? Hell YES.
Hi Dave, Definitely opportunity cost is often measured in something other than dollars and cents! Stop the press, that is an incredible story! 1996 – they must have still had Steve Young, Jerry Rice, and T.O. – amazing! If I remember correctly, 1996 was the year the Favre and the Packers won the Super Bowl over the Pats and Parcells – that was a great year. Speaking of Candlestick, my family and I were in San Fran one August and went to a Giants-Dodgers game – such a cool old stadium, froze our asses off though! Thanks for sharing such a cool story, Rick