Two roads diverged in a wood, and I—
I took the one less traveled by,
And that has made all the difference.
Ooh, I love Robert Frost.
Is that his anthology of poetry?
Nope.
An economics book.
Economics?
Oh, we’re talking about opportunity costs,
aren’t we?
Why, have you got something better to do?
Vic is a food server at an upscale restaurant.
He gets a call from his friend Ben who has
an extra ticket to the My Chemical Romance
reunion tour!
Though Ben paid $60 for the ticket, he’s
willing to sell it to Vic for 40.
Since it’s his second favorite band, Vic
would happily pay twice that.
So he gets someone to cover his shift and
they split an Uber to the concert.
Unfortunately, Vic ends up missing almost
half the show waiting in the beer line, where
he spends another $20.
And the seats aren’t even that great.
As he cranes his neck to see the stage, Vic
can’t help but calculate how much this mediocre
night cost him...
Before you bother doing the math, you might
notice there’s something missing: the work
shift Vic gave up to go to the concert!
Since he typically makes about $150 in wages
and tips on a Friday night, he would actually
be $220 richer if he had skipped the concert
and gone to work instead.
This is an example of what economists call
“opportunity cost,” which is typically
defined as “the benefit that is missed or
given up by choosing one alternative over another."
And it doesn’t just apply to money.
If you decide to eat at a Chinese restaurant
instead of a Mexican one, you might enjoy
the Kung Pao Chicken, but it’s at the “cost”
of not enjoying a plate of enchiladas.
Life is full of such forks in the road.
You (and your wallet) can’t be in two places
at one time, so we’re constantly faced with
decisions about where to put our time and
money.
The concept of opportunity cost encourages
you to look far down both paths and compare
all the ramifications of each option.
This may seem like common sense, but you’d
be surprised how often it’s overlooked when
making financial decisions.
For example, Angela is deciding whether or
not to take out loans to go to college.
She does some research and finds that the
median yearly income gap between high school
and college graduates is around $17,500.
Even if her loan payments are $7,000 a year
(well above average), she’d still be way ahead!
She decides to take out the loans.
While cleaning out his parents’ cellar,
Ted finds an old bottle of wine, and his parents
let him keep it for his trouble.
It turns out to be a pretty expensive vintage,
so that night Ted and his boyfriend enjoy
a fancy bottle of cabernet with their dinner--for
free!
Pamela is looking for a place to rent and
finds a great deal on a nice house with a
big backyard.
The catch?
It’s outside the public transportation system,
so she’ll have to lease a car to commute
to work.
But she calculates that even including car
payments, gas and insurance, she’ll still
pay less than if she lived downtown.
In each of these cases, the decision-makers
have failed to properly weigh the opportunity
costs of their choices.
If Angela goes to college, she may make more
money down the road, but she will miss out
on four years of salary (and job experience)
that she would have gotten with a full-time job.
That cab may seem free to Ted, but it’s
actually costing him $100 not to sell it.
And Pamela has overlooked the amount of time
she’ll spend in the car, which she otherwise
could use to relax, pursue hobbies, or make
more money.
To be clear, that doesn’t mean their decisions
were necessarily wrong, just that they didn’t
have a full picture of what they were giving
up.
Opportunity costs are especially relevant
to people in business or government, where
shareholders and political opponents are more
than happy to imagine how that money could
have been better used.
If an executive wants to spend $10 million
on a marketing campaign, he has to show that
not only will it return a profit, but that
it will return more of a profit than any other
use of that money, like renovating a factory
or developing a new product.
If a city council wants to build a rec center,
it’s not enough to say it will benefit the
community.
It has to create a larger benefit than if
the money were used for any other purpose,
like education or housing.
Opportunity costs are also a key concept behind
“specialization,” which means focusing
on a smaller scope of production to increase
efficiency.
For instance, Elon owns two factories.
Factory A can produce 50 electric cars in
one day, and Factory B can produce 40.
But if they switch production over to his
new Cybertruck, both factories have the same
daily output: 20.
This means that every Cybertruck Factory A
makes comes at an opportunity cost of 2.5
electric cars not made.
Elon decides to have Factory B produce all
his Cybertrucks, because the opportunity cost
is lower.
Even if you’re not an auto executive or
a city councilmember, taking a moment to weigh
opportunity costs before making a decision
will make you a more competent CFO of your
own life.
It’s also a good reminder that money is
fungible.
Every dollar you spend in one place could
theoretically be spent anywhere else.
But it’s important to remember that opportunity
costs refer to all benefits--not just financial
ones.
The experience of college life, the comfort
of a spacious house, and the emotional satisfaction
of treating yourself are hard to put on a
balance sheet, but the benefits are no less real.
Even Vic had no way of knowing that the night
would be a bust.
If he had skipped the show and worked his
shift instead, he might’ve ended up kicking
himself over the opportunity cost of missing
what he imagined to be the greatest concert
of all time.
You can see how thinking too much about opportunity
costs can send you down a rabbit hole of infinite
possibilities and regrets.
You can go crazy trying to weigh every conceivable
pro and con of every conceivable decision.
It’s good to remember that big life decisions
are often more like forks in the road than
a vast, infinite ocean.
You’re usually only deciding between a manageable
number of options, and it’s best to always
face forward, not second-guess where you’ve
been.
And that’s our two cents!
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