ECON100 CONCEPT OF THE DAY: OPPORTUNITY COST
Intro: As part of our dual mandate to rebrand the dismal science’s moniker into the ‘decision’ making science as well as to lower the barrier to understand and access economic concepts without a formal economics degree, we’re rolling out a definition of the day (or week) to further these goals. Today’s concept of the day (or week) is: opportunity cost.
EXACTLY WFT IS OPPORTUNITY COST?
Let’s start from the beginning. Scarcity. Opportunity cost stems from the concept of scarcity. Scarcity forces you (and us) into having to make choices. There’s not enough time in your vacation, enough money in your bank account,not enough space in your suitcase (or suitcases), and not enough books (or movies) from your favorite author or (actor). Scarcity introduces tradeoffs into your life and therefore you must make decisions about which choices to bring into fruition and which choices to defer.
Now for the formal definition: the opportunity cost of an activity is the value of your next best alternative. Opportunity cost further divides into two general flavors: implicit and explicit.
Let’s look at the easier concept first. Explicit opportunity costs should resonate with almost everybody. Those costs are the type of opportunity costs you incur in cash.
- Surprise emergency room visit?
- Skipping the line at a major theme park?
- Experimenting with the latest trending gilded nail style at your local salon?
In most cases, all of these experiences involve explicit opportunity costs.
Implicit opportunity costs are slightly more difficult because of their nuance and don’t involve cash. In a nutshell implicit opportunity costs are things you can spend that aren’t cash. Some examples of implicit costs are:
- Spending quality time with your favorite person (or pet)
- Forgone interest – interest income you could have accrued if you left you money in a bank account but didn’t
- Depreciation – the silent decrease in value of your car, clothes, and other assets from wear and tear as time passes
To recap, opportunity costs are the sum of the costs that you incur in cash (or cash equivalent) plus the costs you incur that aren’t cash. Below is a formula to represent
Opportunity costs = implicit costs + explicit costs
Why should we care about the concept of opportunity cost?
Because understanding opportunity cost is the key to making better choices as a lifelong economist (which you are). As clinical psychologist Meg Jay eloquently explains in her TED talk Why 30 is not the new 20¹, a person’s 20’s can be used as a springboard into adulthood, and young adults who fail to use their 20’s as such have missed an important opportunity to transition into adulthood.
OK, so what does opportunity cost mean for you?
Embrace art. Embrace your inner artist. In Mark Manson’s The Subtle Art Of Not Giving A F**k, Mark explains how once you decide who you want to care about you can focus all your effort on that one thing. You can check out a video summary of the book done by the author himself on Youtube here. Around 84 seconds into the video, Manson describes the overarching point of the book². Despite the contrarian title, he explains the main thrust of the book is about values. Picking a few things to give a f**k about means other things become relatively inconsequential and matter much less. Once you understand opportunity cost you can make better decisions by fully accounting for the value of your next best alternative. Now you’re looking at step zero. The step that precedes charting a course for your future goals. “The real important question of getting ahead in life or improving our life is not necessarily figuring out how to accomplish every single goal we have, it’s more in asking ‘what sorts of goals should we have in the first place?’” Perhaps this is best brought to light by the question “Is college worth it?”. Before you answer that, proceed to step zero by asking yourself “What are my goals?”. In Manson’s video summary Subtlety #3 is that you’re always choosing what to (and what not to) give a f**k about. Every choice has its consequence which at its core succinctly defines opportunity cost.
Another great illustration is Ramit Sehti. Author of I Will Teach You To Be Rich, Ramit explores the difference between Cheap vs Frugal, with the help of ABC’s Tayna Rivero in this Youtube video clip. At the core of Ramit’s argument is his observation consumers behaving frugally are systematically using opportunity cost in their decision making process. They are perhaps prepared to spend more on certain goods and services because they value those particular goods and services more. Goods and services which are not valued highly are under-consumed or not purchased altogether.
REFRENCES
- Jay, Meg. “Why 30 is not the new 20.” TED, May, 2013, https://www.ted.com/talks/meg_jay_why_30_is_not_the_new_20
- “The Subtle Art of Not Giving a F**k.” Youtube, uploaded by Mark Manson 2021, https://youtu.be/lz8sUiXAnbs
- “Ramit Sethi on ABC News- ‘Cheap vs. Frugal.” Youtube, uploaded by Ramit Sethi, 2009, https://youtu.be/O9nwHrqosD8