Every day, you make several decisions, big and small, that impact your life and the lives of others, even if you don’t realize what you give up by choosing one option over the other. These missed benefits are what economists call the opportunity costs of your decisions. Whenever you say “yes” to an option, you also say “no” to the alternative. These five steps will help you integrate opportunity cost into your decision-making and feel confident that your choices align with your values and vision. (Estimated reading time: 9 minutes)
Intelligent people make decisions based on opportunity costs.– Charlie Munger
As a kid, I spent a large chunk of my evenings and weekends gaming. I would immerse myself in the adrenaline-filled worlds of characters like Donald Duck, Spiderman, and Michael Jackson, navigating levels and tackling treacherous ghouls, ghosts, and gangsters.
Video games are different from movies, books, and TV shows in the inherent focus and time they take up. They take longer to consume than watching a show or reading a book, and the instant gratification games offer can make us addicted to them if we’re not mindful.
For the longest time, I wondered whether I made the right choice to spend my time gaming at the age when my brain was a sponge. I could have used that time to play outside with my friends, learn a new language, take a dance class, or spend more time studying to achieve higher grades. When I took my first economics class, I learned that there was a term for the other activities I forfeited in my youth called “opportunity cost.”
Economists define an opportunity cost as the most high value opportunity you give up when you make a choice. It’s the healthy salad you skipped in favor of the cheeseburger. Or the 9-5 job that you gave up so you could pursue your entrepreneurial venture. It’s a life of singledom and other eligible partners that you willingly forgo to marry that special someone you love.
Every choice we make incurs a cost. Even if we believe that we’re getting the best deal, there are opportunities we lose out on in the process. The key is to be aware that we are pursuing what we value because the pursuit cancels countless lost opportunities in its wake.
While coming to grips with the opportunity costs of my gaming hobby, I’ve also accentuated the positives highlighted by several studies on the benefits of video games, like how they improved my creativity, memory, and concentration and how role-playing enhanced my problem-solving, spatial, and hand-eye coordination skills.
When seen from this perspective, I’m convinced it was time well spent. It met my needs for fun, learning, and exploration – fundamental values still important today. In the end, it was all worth it.
Everything in life has an opportunity cost
Every day, you make several decisions, big and small, that impact your life and the lives of others. Have you ever wondered what you are giving up by choosing one option over another?
There may have been occasions when you were aware of the sacrifices. You may have said to yourself, “If I don’t take action on this, I may regret it later.” When faced with several options, a conscious decision maker knows the importance of factoring in the potential forgone benefits of their choices when making their final selection. For example, if you decide to spend the evening completing a project, the opportunity cost is the quality time you could have spent with your kid at home.
The popular aphorism, “There’s no such thing as a free lunch,” is predicated on the idea that every choice we make has a cost attached. In this case, the costs are the advantages of the options we decided not to move forward with.
Narrowing down our choices is necessary because resources are scarce. Time, money, attention, and mental bandwidth are limited and require us to choose where to focus them. Like a spotlight, we can only shine our light of awareness and efforts on a small area.
We need to ensure that our light is being used in the best possible way. For instance, to pursue your dream of becoming a surgeon, you must first consider the opportunity costs of the other specializations you had in mind.
Opportunity cost matters because it drives us to consider what really matters and what does not. We must ask ourselves, “What are my values and priorities?” and “What am I willing to sacrifice to live a life that aligns with them?”
In this way, you avoid making choices that lack meaning, are counterproductive, irrational, and wasteful, and instead, direct your precious resources to create a life you truly desire and love.
Types of opportunity costs
Not all opportunity costs are created equal. There are two types that we need to consider when evaluating the costs of our options: explicit and implicit.
Explicit opportunity costs
Explicit costs are the direct costs incurred when taking a specific course of action. Let’s say you have decided to attend university instead of taking a gap year to travel and teach abroad. The explicit cost of college is the money you don’t earn from your teaching gig. Not only will you make less money as a student, but you might also need to take out student loans.
But if you decide to hold on to the thousands of dollars you would be spending on a college education and use it instead to invest in a startup, your explicit costs will have the potential to earn a regular paycheck in a high-skilled position. You miss out on increased future earnings, especially if your startup idea needs to be better thought-out and backed up by marketing research.
Implicit opportunity cost
Implicit opportunity costs, on the other hand, are indirect costs that may or may not be incurred by forgoing a specific action. They include the money or other non-monetary benefits you may have gained had you made a different choice and can be difficult to identify because they are not clear-cut.
In the case of opting to go to college instead of taking a gap year to travel and teach, an implicit cost would be the knowledge and enrichment from visiting another country, interacting with people from other cultures, and learning a new language. However, you can’t be sure if you would have experienced these benefits unless you had gone ahead.
The implicit opportunity cost of choosing to build a startup instead of going to college is the fun and camaraderie you could have had with friends at university and the mentorship you may have received from college professors. You could also miss out on networking opportunities for job fairs and career-building activities on campus.
When evaluating the opportunity costs, it’s essential to look at those that involve finances and those that pertain to quality of life and character and skill-building lessons.
5 steps to calculate opportunity costs before making a choice
As much as we’d like to believe that we can have it all, the reality is that everything in life has an opportunity cost. Whenever you say “yes” to an option, you also say “no” to everything you could have gained from the alternative. That’s why when evaluating options, your vetting process needs to include considering the opportunity costs. In doing so, you’ll minimize regret or “buyer’s remorse” and feel confident that you made the right decision that aligns with your values.
Following these five steps will help you integrate the concept of opportunity cost into your thought process and use it as a tool to apply wisely to all your decision-making.
1. Get clear on your values and goals
Before considering opportunity costs, it’s essential to clarify the values, ideals, or beliefs you hold that are essential for determining what’s desirable to you. Your values serve as a guide as you sift through your options. For instance, if you value freedom and variety, a freelance career would be better for you. You wouldn’t mind the opportunity costs of a predictable and structured environment and a typical 9-5 job schedule.
Similarly, you should also set clear, realistic goals reflecting those values. These will provide additional criteria as you analyze alternatives and their opportunity costs. Select the option that offers the highest value in achieving your goals and the lowest opportunity costs that take you further away.
2. Identity your alternatives and estimate their opportunity costs
Before calculating the opportunity costs of your choices, you must first identify the available alternatives and then determine their value. For instance, when choosing a destination for your vacation, list all the places you have in mind, what you’re most looking forward to seeing and doing in each destination, and estimate the costs.
As you do this, distinguish the implicit and explicit opportunity costs of each one. Remember that the value of an alternative can be perceived in different ways, such as time, money, usefulness, or satisfaction. In the case of a vacation, the explicit costs would include the airfare, hotel, and tour expenses and the implicit cost would be the enjoyment and quality time you spend with a travel companion.
3. Take stock of your resources
Opportunity costs are subjective and will appear differently to people based on how many resources they have. For instance, the opportunity cost of missing out on saving $100 on buying a bag on sale is much higher for a person who earns $10 per hour compared to someone who makes $50 per hour.
Take an inventory of all the relevant resources that you must consider in making your decision. This can include finances, time, effort, mental bandwidth, and how much you will expend to achieve your goals.
4. Reduce opportunity costs
Another tactic to get the most from your choices is to reduce the opportunity cost of your decision. This can be done by making choices that maximize the benefits and minimize what you’re giving up. To do this, you’ll need to look at all relevant factors and the possible outcomes of the options and weigh them against your goals.
Identify ways to boost the value of your chosen option and lower the value of the alternative. For instance, if you decide to get a job instead of going to university, you can decrease the opportunity costs by going for a position that offers opportunities for education and mentorship. You can also look for a higher-paying position to save money that you can use should you choose to go back to school in the future.
5. Avoid opportunity cost bias
Opportunity cost bias is caused by our blind spots. It can lead us to ignore or underestimate the potential outcomes of our choices, resulting in choices that aren’t rational, suitable, and can even harm our long-term objectives.
A classic example of this is continuing to invest our emotions and time in a romantic partner we know is not suitable for us, despite the potential of meeting a new person who can make us happy. We choose to stay miserable in a dead-end relationship because we aren’t acknowledging the high opportunity cost of leaving them and finding a healthier and more fulfilling relationship.
To avoid opportunity cost bias:
- Become aware of the emotions, fears, and assumptions influencing your decision-making.
- Get feedback from those who are objective and have no stake in your decision.
- Research and seek out additional information that will facilitate your ability to compare the opportunity costs from a place of curiosity, openness, and creativity.
Writer James Clear said, “Every action you take is a vote for the type of person you wish to become.” I would add to this by saying that every action that we choose not to take is also to vote for the type of person we want to become. By saying no to a particular option, we are saying, “This option isn’t enough to get me closer to my ideal self”. Looking at opportunity costs is instrumental in creating our identities and, eventually, our destinies.
All my best on your journey,
Questions for you: What are the opportunity costs of some of your most critical decisions? Looking back, how do you feel about the options you passed on?
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