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We all make opportunity cost decisions every single day. After all, the phrase. “opportunity cost” is just a fancy way of saying that you have to make a trade-off decision. This or that.
Think about the last choice you made. Perhaps you were faced with many appealing options, but you ended up choosing the one that provided you with the most value.
So what did you give up by passing on the other choices?
We all make about 35,000 choices every day, which means there are a lot of things that we decide against as well.
One of the choices that I struggled with recently was whether or not I should take a day off from work when a good friend was coming into town.
While I wanted to see my friend, I knew that taking a day off from work would result in lost wages.
I ultimately decided to spend that day with my friend and give up the opportunity to earn money because seeing my friend was more valuable to me. However, the opportunity cost to do so was clear.
Any decision that requires you to make a choice between at least two options has an opportunity cost. Opportunity cost is not the same as what we typically think of when hearing the word cost, as it is not necessarily related to finances at all.
Considering your opportunity costs helps guide rational decision-making.
Opportunity costs are unseen, so they can be easily overlooked if you’re not careful. Understanding the potential opportunities that you’re giving up by choosing one thing over another is a critical factor in making good decisions.
With all of life’s constraints in mind, the constraint of time is one we can’t avoid. Getting the most value out of your life means using your time wisely, which requires understanding opportunity cost.
In this article, I will further discuss the concept of opportunity cost, explain how you can calculate it, offer examples of opportunity costs that may apply to your life, and then give you a step-by-step guide on how to apply this principle any time you’re faced with a major decision.
Let’s start by exploring this concept a bit further.
What You Will Learn
- What is the Opportunity Cost Concept?
- How Do You Calculate Opportunity Cost?
- 7 Examples of Opportunity Costs
- Examples of “Opportunity Cost” Application
- Final Thoughts on Opportunity Cost
What is the Opportunity Cost Concept?
An opportunity cost is primarily used as an investing term that refers to what you’re giving up when you forego the second-highest valued alternative in order to make your primary choice.
When it comes to financial investments, people are faced with choices regarding where they want to invest money in order to earn the best return. When you pick one alternative over another, the cost of missing out on whatever benefits the other option could have provided for you is your opportunity cost.
The opportunity cost concept can easily be translated into everyday life and decisions that are not financially related.
For example, if you spend your time sleeping in before work, you cannot also spend that time going to the gym for a morning workout. Essentially, you can’t have your cake and eat it too.
In order to get what you want out of life, you have to adopt this economic mindset. You need to be aware of the things you’re giving up in order to get something else.
However, people don’t typically like to think about the things that they are giving up.
It is easier to avoid analyzing any costs that aren’t obvious and just make a decision that will have the most benefit at the moment. Dwelling on the decisions that we chose to not make in the past can easily lead to a sense of regret.
Opportunity cost is a powerful tool that you should apply to all of your life’s decisions. If you incorporate this concept into your thought process, you will make sensible choices and gain a better understanding of the world around you.
Every decision that you make comes at the expense of another option. Each option presented to you in any mutually exclusive decision can be obtained at the cost of the other. But how do you know what that cost is? Let’s look at how you can calculate the opportunity cost of choosing one option over another.
How Do You Calculate Opportunity Cost?
While there is not a specifically defined formula to help you calculate an opportunity cost, there are three key factors that are always involved in opportunity cost: money, time, and effort (AKA -sweat equity)
Here are a few ways that you can think about this cost in an objective way.
The decisions that you make generally involve limitations such as time, money, rules, cost versus quality, risk versus reward, salary versus quality of life, etc. Think about what you’re giving up compared to what you’re gaining by declining the second-best option.
So, you can calculate the opportunity cost as:
Opportunity cost = the return of the most profitable option minus the return of the option that you choose.
Or, in other words:
Opportunity cost = the difference between what you’re sacrificing and what you’re gaining
When taking a closer look at this equation, it is clear to see that opportunity costs revolve around weighing your options before making a decision. The goal here is to evaluate your choices to determine the value ratio among your options and make a decision that offers the most value, regardless of whether or not that value is financial.
What are you sacrificing compared to what you’re gaining? What can’t you do as a result of each decision that you make? Once you spend your time or money on one thing, you can’t go back and spend it on something else.
Let’s consider what this might look like in the decisions that you make in everyday life.
7 Examples of Opportunity Costs
1. Going to College
The decision to attend college is one of the most important decisions you will make. Whether you choose to go to a state school, a private liberal arts school, or no college at all will have a long-term impact on your career and your debt. It is important to assess all possible options, benefits, and costs before deciding how to proceed.
The Bureau of Labor Statistics shows that a typical 25 year old with a high school diploma made an average of $718 per week in 2017, while those with a bachelor’s degree made an average of $1,189 per week.
But what about those who don’t want to attend college or those who could only go by taking out student loans and accruing debt? Is this something that people should take on if it’s not their chosen path?
Because there are a lot of great careers that don’t require a college degree, the opportunity cost of taking the time and money to go to college wouldn’t be worth it. On the other hand, if you choose to take on the expenses of college, you will gain new experiences and have a sense of accomplishment that you could value more than the money you spend.
2. Salary Versus Quality of Life
You’re already in over your head with work as it is–you work late into the evenings, rarely see your family for dinner, and constantly feel stressed out about the amount of work that you have on your plate. However, you’re clearly producing great work because you just got offered a promotion that includes a big increase in salary. You know that taking this promotion would impress your boss and set you up for even more future career success.
But, if you take the promotion, your quality of life will decrease even further–and because of that, the quality of your work may suffer. Your already non-existent social life will be history and you will see your family even less. Would accepting this promotion involve taking away too much from other things in your life that you value?
You have to consider the gap between what you will be gaining and what you will be losing and analyze if that gap is too big (or small) to be worth it to you.
3. Quality Versus Price
You’re out shopping for a new car and the one that you fall in love with is $5,000 over your budget. There is another one that would be acceptable that is a great deal–way below your budget–although it already has high mileage.
What would you be giving up if you decided to get the less expensive car? Aside from some modern features, you may also be giving up the amount of time the car will last you.
On the other hand, if you choose the more expensive car, you will have to find a way to bridge that gap in order to make your monthly payment–but, you know the car will last for a long time and you would buy it with peace of mind that it won’t end up in the shop within just a few months. The less expensive car, however, could end up costing you extra money, time, and effort in the long run that the more expensive car could spare you.
Choosing your spouse is obviously a major life decision that should be considered with care. But let’s say you’re getting older and you’re ready to settle down and have a family. You really want children and want to get married sooner rather than later because your biological clock is ticking.
You meet someone who checks all the boxes for what you want in a spouse, but maybe the person doesn’t feel like the love of your life. However, this person is very much in love with you and you love them as well, just maybe not the level of love that you imagined “happily ever after” to be.
This person proposes to you. Do you say “yes” and start working toward your goal of having a family? Or do you take the risk of saying “no” because you don’t want to settle for “good enough”? If you say no to the proposal, your main opportunity cost will be time, but there is also a potential cost of not being able to find a partner who will help you live a full and happy life.
5. Hiring Help vs. Going it Alone
The decision to do things for yourself versus hiring help is a great application of the concept of opportunity cost. Doing things yourself is typically less expensive than hiring someone, and it can even be enjoyable.
For example, let’s say you’re ready for some new paint colors in your house and you actually enjoy the process of painting. However, the cost of painting your walls yourself instead of hiring a professional is the value of anything else that you could have done with that time, such as working and making money.
However, there are also non-financial costs involved that can be even greater than the monetary costs. If you choose to paint your house yourself, you’re also giving up time that you could otherwise be spending with your children or engaging in a hobby that is truly your passion. The opportunity costs of self-sufficiency can actually be higher than you initially realized if you look beyond the financial aspect.
6. “There’s No Such Thing as a Free Lunch”
You can consider this common saying in a literal way when talking about how to calculate opportunity cost. If someone offers to take you out to lunch, sure, you will avoid spending that $15 that you would have spent to go out and get your own lunch.
However, there is an opportunity cost involved because you’re losing time that could have otherwise been spent on something more important to you. Additionally, let’s say you had to clock out while going to lunch. If this is the case, you’re also losing out on wages that you would have earned if you had eaten lunch at your desk.
This means that if the time spent at lunch with this person does not benefit you in you some way, then not only are you making bad decisions with your time, but you’re also forfeiting money that could be on your paycheck.
7. What’s for Dinner?
This is clearly a more everyday, menial decision that you have to make, but it is a decision nonetheless. If you choose to eat at home, you may throw something together that is possibly mundane and just call it a night. However, this would save you time and money.
However, if you want a great meal, you can choose to go out to dinner. This can also give you a chance to catch up with friends or socialize in some way, but it will be more expensive and take more time than simply eating at home. It will also take more effort if you need to go home to change after work, get ready to go out again, and then get home late.
There are several factors that go into this decision aside from just the financial cost of eating at a restaurant.
Now that you can see some areas of your life where knowing how to calculate opportunity cost can be beneficial, let’s look at a step-by-step method that you can use to apply this principle to your decision-making process.
Examples of “Opportunity Cost” Application
Example #1: Changing Careers
Let’s consider the example of changing careers. This is a big life change and the process that you use for making this decision can be applied to other big life changes that you face as well.
You’re ready to move on from your career, but you’re not sure when you want to make this change. You decide that you will quit your job as soon as you’re unable to justify the amount of money you’re making. However, without defining exactly what this looks like, you could end up staying in the job forever because you’re nervous that your next career endeavor will not be as lucrative.
So when should you quit?
Keeping opportunity cost in mind, you can get a more concrete idea of exactly when staying at your job is more costly than moving on. First, consider the costs associated with quitting:
Then, you must also consider the opportunities that you would be giving up by staying in your current position:
When you think of it in these terms, you will see that you should quit your job when the cost of staying outweighs the cost of leaving. This also gives you the chance to reduce the costs that are associated with leaving your job, which then increases the costs of staying.
For example, considering the potential that you could have to make new friends in a new industry reduces the social costs of moving on from your current job. Further, quitting your job may give you more time to create an even larger professional network within your new field of work than what you currently have.
Keeping opportunity cost in mind and understanding the concept can make it easier for you to recognize when you can’t justify staying at your job because you’re simply not getting enough value out of being there.
Example #2: Going Back to School
Let’s consider another example of going back to school. It is not uncommon to either take a leave of absence from college to pursue a unique work opportunity or to graduate and simply realize years down the road that you want another degree. Even if you’re comfortable in your career, you may want to advance your education.
On one hand, you’re doing fine in your current job and you don’t have the added expense of school or the added time commitment. However, you recognize that there isn’t too much more room to grow in your profession and you feel like you have a lot more to offer to the world.
If you ask your friends and family, they will likely tell you to go back to school to get another degree to become more well-rounded or that “now is the time” to do it before you get too far into your current career. But these bits of advice are not keeping opportunity costs in mind. To get a more clear picture, think about the costs associated with not going back to school:
Now, look at some of the costs associated with returning to school:
However, not getting another degree isn’t one of the costs associated with staying at your current career. You can always go back to get another degree. So when others say “now is the time”, it is more for you to decide what is right for you.
Remember, in order to be successful, you have to be absolutely clear on exactly what you want. Once you know what you want, you have to forego any opportunities that are presented to you that take up time, effort, or resources that could be better used toward helping you meet your goal. Say “no” to anything that will not ultimately move you forward in some way.
People often make decisions that are impacted by fear in some way–a fear that if you don’t jump on an opportunity then you might lose your chance to ever do so. People have a scarcity mindset that suggests there is not enough work, money, career opportunities, or time to go around. The problem with this is that living in this mindset influences people to agree to do things that they know aren’t a great fit for their goals.
Final Thoughts on Opportunity Cost
Seeing as almost all of the choices that you make have an alternative that can possibly be beneficial as well, you will never be able to completely avoid opportunity cost.
Every choice in life is about opportunity costs. Whenever you say “yes” to one thing, you’re saying “no” to any other options of how to spend your time, money, and resources.
However, it’s important to not dwell on the what ifs in life or the things that you should have done, as this can result in choice paralysis. Instead, be realistic and sensible when you are making decisions so you can confidently choose what is best for you in the long-run.
Whether you’re considering going back to school, thinking about changing your career, making an investment, buying a house or a car, or simply trying to make vacation plans, keeping the value of foregone alternatives in mind will help you make better and more informed decisions. Make sure that the process in which you make decisions is based upon the concept of opportunity costs, and embrace the fact that you’re able to choose how to arrange your life in this way.
I hope you enjoyed this article and now understand how to properly calculate opportunity costs in your life as well as you do with your financial decisions.
Finally, if you want to take your goal-setting efforts to the next level, check out this FREE printable worksheet and a step-by-step process that will help you set effective SMART goals.
Connie Mathers is a professional editor and freelance writer. She holds a Bachelor's Degree in Marketing and a Master’s Degree in Social Work. When she is not writing, Connie is either spending time with her daughter and two dogs, running, or working at her full-time job as a social worker in Richmond, VA.