Old clock. Source: http://www.flickr.com/photos/gc_photography/3207883698/Everyone is familiar with the direct costs of life. You feel it every time you take some money out of your wallet to pay for food, gas, or tuition. Are you familiar, however, with the indirect costs, and the choices that you make everyday? I am not referring to hidden taxes or fees (such as bank fees); I am instead referring to opportunity costs.

The seen versus the unseen

At the most basic level, an opportunity cost is about what is seen, versus what is unseen. When you choose to spend $1,000 on a new flat screen TV, you aren’t just spending $1,000 of your cash: the costs go far beyond that. You are also giving up the ability to pay down $1,000 on your mortgage, saving you many hundreds of additional dollars on interest costs. You are giving up the ability to fund your child’s future education. You are also perhaps giving up the opportunity to save that money for a vacation to your dream destination. You also have to consider all of the time you might spend watching Jersey Shore or something like that. :)

An opportunity cost is the cost of spending your time, money, and energy on one thing, instead of another thing. As you can see, opportunity costs play a big role in personal finances. Every choice that you make in life has an opportunity cost attached to it, even if it is not easily seen. An opportunity cost doesn’t only include monetary costs, but it includes all real costs of making one choice over another, including the psychic profit of lost time, energy, and pleasure.

Awareness of these opportunity costs is very important. Everything that we do in life has an opportunity cost attached to it. For every decision that we make, an alternative decision is possible, and the difference in outcomes is the opportunity cost that we face. The costs and benefits of these alternate decisions, as well as the unseen effects of the decisions that we do make, must all be considered. Frédéric Bastiat is a well-known economist who popularized the notion of the seen versus the unseen, and why we must always be on the lookout for both.

Personal opportunity costs

Although opportunity costs are an economic concept, they play a part in every personal decision that we make. When I decided to play a lot of games during my high school days instead of focusing on academic performance, I paid the opportunity cost of potentially lost scholarships, bursaries, etc… that could have helped me out in college.

In choosing to work a 9 to 5 job to pay down the mortgage and accumulate savings, I am paying another opportunity cost: The cost of not being able to travel, see the world, and spend my time doing something else and spending more time with the people I care about.

The opportunity costs of political decisions

There are many opportunity costs associated with political decisions as well, and this is one arena where it is very easy to see a strong bias toward the seen benefits with a corollary ignorance of the unseen costs. We can see this with social security, where benefits payments have been squandered by the government over the years, and an unhealthy reliance on public spending has been created. We can also see this with other government actions, such as TARP and the bailouts of Wall Street, as well as other examples of profligate government spending, and the long-term consequences of kicking the can down the road.

I’d like to share another example which has touched my life personally. Most countries these days enforce a minimum wage set by law, and on paper, these minimum wages seems like a good idea. First, we set a price floor on the minimum wage, which prevents businesses from paying their employees less than this price floor. By doing this, we increase the purchasing power of those workers on the lowest rungs of the ladder. This increased purchasing power will then filter around to other aspects of the economy, making everyone better off.

The problem with this analysis is that it focuses solely on the seen effects of the minimum wage, and completely ignores the unseen effects. By setting a price floor on the minimum wage, we also prevent employers from hiring employees below this price floor. These employees are then forced to go on public assistance or to take less productive jobs, or they will be forced to work under the table.

I personally know someone who is training to become a chef. Because of the low margins of the restaurant business and the long hours involved, many restaurants cannot even afford to pay my chef friend in training the minimum wage. How much would this be? At $10 an hour and 60 hours a week, this would be $600 per week; with overtime pay, this is $700 per week. With employer-side overhead and payroll taxes, they could be looking at between $900 to $1000 in total costs per week, if not more. This is the minimum they would be legally required to spend on him. He is not an experienced chef; he is an apprentice, and to pay him that much would be a big risk to take on someone who has not yet proven himself. However, the restaurant cannot legally pay him anything between $1 and $699 per week. My chef friend is therefore forced to either work for FREE, or to accept some payment in other forms or under the table, including working for food and receiving free lodgings.

While this sounds highly exploitative to some people, what they need to understand is that businesses are dictated by cost and revenue. Please note that I am not suggesting that it is OK to exploit employees. Suggesting that these businesses are exploiting employees is looking at only one side of the coin. On the other side of the coin is unemployment and welfare, and a lost chance to climb the ladder and gain real work experience. I personally started out working at far less than minimum wage, myself, though in a legally exempt job.

If an employee is not even allowed to take a job because he is legally forbidden from negotiating a voluntary contract with the employer, he is prevented from having a job in the first place, and that is unfortunate. If a business cannot afford to hire someone at a given cost and they cannot reduce that cost, then they will not hire that person. Not every business is a “filthy rich corporation”, and for many of these people, it can mean the difference between staying in business or closing up shop. My friend, arguably someone on the margins who should be *helped* by minimum wage laws, is punished instead. Because he loves cooking so much, he is willing to do what it takes to learn, even if it means living on the margins, and literally working for food. It is not fair that he cannot negotiate a wage which he and the restaurant would both be voluntarily willing to accept and which the restaurant can afford, or at least, to not be able to do so within the boundaries and protections of the law.

My friend is but one small example of the unforeseen and hidden costs of a “feel-good” law such as minimum wage. These laws enjoy popular support because the seen effects are easy to spot: The minimum wage workers make more money and can take more money home to their families. It feels good to help out those on the lowest rungs, doesn’t it? What is not seen is all of the dollars taken out of the consumers in the form of higher prices, the dollars taken out of the taxpayer in the form of higher taxes to support those made unemployed or unemployable due to the effect of the price floor, and the unforeseen wealth lost by everyone from the lowered output of society.

Those on the lowest rungs are often those hurt the most by the very same policies that were meant to help them out. Customers are forced to pay for it in the form of higher prices and higher taxes, businesses are forced to pay for it in the form of reduced revenue, and employees are forced to pay for it either in the form of lost income, and lost opportunities for gaining experience, or in the uncertainty and insecurity of working for food or working under the table, and without the legal protections of the law.

Opportunity costs and you

My chef friend is paying a significant opportunity cost by pursuing his dream of becoming a chef: He has postponed his education and career. He was close to graduating with a very high GPA in engineering, but he comes from a society where you are not worth anything unless you get a degree and work for a large multinational company, and that is not the path where his heart truly lies.

Finally, to tie this back to personal finance, I’d like all of you to think about the opportunity costs of every dollar that you spend, and what else you could have done with it instead. It’s an ongoing legend that part of Warren Buffett’s notorious frugality comes from the fact that he places a very high bias on opportunity cost. For him, spending $4 on a cappuccino doesn’t merely mean $4 lost today; it also means a potential $40 or more in foregone future earnings and capital growth. As for helping out others, instead of letting your tax dollars try and do that for you and washing your hands of the responsibility, you have the choice of much better ways of giving. The effects of the unseen can work in an advantageous way, here, as a little bit of help directed to the right place can go a long way.

While this thought process can sometimes be taken to extremes, I would like to enjoin all of you to think about what else you could do with your dollars, and to think about these foregone opportunities the next time you decide to spend those precious dollars, or spend your time doing something that does not maximize your life expectation. No matter how wealthy we get, money and time will always be scarce, and therefore we will always have to evaluate the tradeoffs for every decision that we make.

Recommended Reading

So, reader, what do you think about the role opportunity costs play in your life, and what do you think about my friend’s journey? I have been feeling a little more abstract in my thoughts these days.

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About

Kevin has left the office, and he is currently fighting the rat race by working on his own business. He enjoys exploring unvisited places around the world and gaining new experiences. He believes that by properly managing our energy and time, we can learn to invest our lives wisely.

76 Comments Kevin on Oct 19th 2010

76 Responses to “The Importance of Opportunity Costs, and Why They Should Not Be Ignored”

  1. Kevin, I definitely think opportunity cost are a very important, but often neglected, consideration for our decisions. We don’t make choices in a vacuum. There are substantial downstream ripples, even if they do go unnoticed or unacknowledged. Anyway, Warren Buffet is not alone; such long-term thinking is quite common among those who build substantial wealth according to multiple data. In fact, I believe investing would be less appealing if you only looked at the initial costs, but if you look at the long-term (final) costs of not investing, the choice is quite simple indeed. Interesting post as usual!

    • Kevin says:

      Very true, Roshawn. One can’t live only for either the short-term or the long-term (i.e. I don’t see a point in frugality for frugality’s sake; if you have the money and want to splurge a bit, why not), but to me, the point should be about maximizing your total life expectation. There is a balance between spending, saving, and investing where you will find your maximum happiness level.

      For example, taking a year off to travel the world would impact your long-term savings, but it could provide an experience you would never forget. OTOH eating at restaurants every couple days is probably not adding all that much to your life, but it’s destroying your long-run savings, and therefore your life expectation. One needs to take this long-run picture into consideration even with these small decisions!

  2. Great post as usual Kevin.

    I really think most people do not think one iota of what they are giving up by spending their money today. Life is short, who knows what tomorrow will bring, blah blah blah. Better enjoy life today! People work hard and deserve big vacations and expensive electronics.

    It is true that life needs to be lived and enjoyed. But it also requires work. If you haven’t worked hard enough to truly afford the luxuries, then you really shouldn’t spend the money. Not many people think like that anymore. Why give up spending a dollar today when there is no guarantee you will be around to enjoy the 10 dollars years down the road.

    If people thought for more than 3 seconds about many decisions in life, we wouldn’t be in the economic mess we are in.

    • Kevin says:

      Very good point, Kris. I know a friend of a friend that eats at expensive restaurants a couple of times a week and takes expensive vacations every year, but she doesn’t have much savings at all, and her salary is a typical graduate middle-class salary (read: not very high). It really does come down to subjective values, but I do think that she does not want to keep working for the next 40 years and end up destitute.

      If these people were more aware of the true opportunity costs of their actions as well as the fact that we’re bound to have long lifespans these days (if we still died at 40 then I would probably do like her, too), then their incentive structure would change and they would be more compelled to save and invest for the future, as that would increase their total life expectation (and they would not end up destitute seniors).

  3. One should keep a balanced approach when it comes to spending money. I am sorry to disagree with Warren’s Cappuccino dilemma but people need to live this life and have something to look back to.

    I am not advocating getting into debt to enjoy life’s materialism, I am simply pointing out that extreme frugality is not the way either. Looking back at your life you will remember the dumpster diving episodes or the bananas u had for dinner?

    • Kevin says:

      Haha, it’s OK to disagree with Warren on that point. I believe that opportunity costs should not be ignored, but once you are aware of them, it’s up to you to determine the right balance that maximizes your life expectation and happiness. If you are happier having that cappucino every now and then, and it does not lower your future happiness (i.e. you are not working in a job you hate to pay for that cappucino, or you are well-set for your future and will not be destitute) then why not?

  4. I think the minimum wage is a good thing, despite the impact on hiring. The bad thing was that the Feds didn’t raise the minimum wage for 10 years, which swelled the numbers of working homeless and working poor in our country.

    Corporations pay their CEOs millions of dollars per year, while complaining about the $8 minimum wage for their employees who bust their butts. For smaller businesses, it is definitely a lot harder to afford employee wages. But, we can’t have people who are working 40+ hours per week and still can’t afford the basic necessities of life.

    • Mark says:

      I think that is my biggest gripe. I don’t understand how a worker cannot get $7.25 an hour when CEO’s at companies like Yahoo and Motorola are paid a fortune for nothing.

      • Kevin says:

        It does seem unfair, especially when you see CEOs that ruin their companies and get a golden parachute, anyways. The US might be a little weird in this respect. However, there are other cases where the CEO rights the company and helps to preserve all of those $7 (and $10, and $12, and $15, etc…) jobs from being disrupted. Maybe that high CEO pay is not always undeserved.

        • Cognoramus says:

          The problem with that is that most CEO’s seem to be payed based on a scale that doesn’t take their performance into account. The guys who do the right thing and run their companies ethically are only doing it based on their own motivation, not because they’ll get payed more for it, which means that there are fewer of these “good” CEO’s than there would be if their pay were determined by performance.

          • Kevin says:

            What can also happen is that they get rewarded for short-term targets, but at the expense of the company’s long-term profitability. These policies can reward short-sighted performance targets that miss the big picture.

            I guess there’s a lot of room for improvement there.

    • Kevin says:

      Living a minimum-wage lifestyle sucks, but what if the alternative is no job? The problem with setting a price floor is that it cuts out the most marginal people; they are the ones that will suffer. The big corporations might not care that much, but you will hurt a lot of small business owners, and you will hurt the people who now cannot find a job, as well as the people who have to pay higher prices. Rich people won’t care about higher prices, but people on the margins will.

      I lived a min-wage lifestyle myself, all through college. Well, almost: Most jobs I got paid a few dollars above minimum wage, although they are all menial jobs, including lifting boxes all day. My entry, however, was in a below-min wage job (paperboy) and min-wage job (landscaper). I would have not had the leg up to those somewhat better jobs (which helped me complete my education) had I been locked out of the min-wage jobs by a raised price floor.

  5. Very good point about minimum wage. I think in general people assume that it’s a good thing at all costs. I can definitely think of examples where I would have worked for less than minimum wage (as an apprentice of something) in order to learn a marketable skill. I wouldn’t do it for free, but for a token amount, yes. Or in high school, I’d probably work at a movie theater or concert hall so that I could get free tickets to things.

    Great article. You always provide a very balanced view.

    • Kevin says:

      Thanks for the feedback! I was somewhat more resentful about this when I was younger than I am now (“those guys are so cheap! Paying me peanuts…”), but I think it comes down to the seen vs unseen. I didn’t see as many of the benefits when I was younger. ;)

  6. Mark says:

    This post made me think back to my economics class in college. You do have to weigh the consequences of every decision that you make. This even applies to time management. Every minute that you spend doing one thing is taking away from your time doing something else.

    • Kevin says:

      Definitely. I first heard about this from economics class, too, but it’s a concept which applies to everything we do in our lives. The balance is different for everyone, but when you’re not aware of what you’re giving up, you don’t worry about these things. The danger comes in 20 years or so when you realized you haven’t saved much at all, and you realize that you’re in danger of becoming a pauper in retirement.

  7. Aloysa says:

    I think one should decide what he/she is willing to forgo now in order to have/do something better in the future. It is good in theory. In reality, a lot of people act on their impulses and emotions, looking for an instant gratification. Great post!

  8. It’s interesting how you compare short term decisions with long term goals. I think it’s in our nature to put off long term goals until later. It’s a real mindset change to be thinking that your today decisions are affecting tomorrow as we speak.

    It seems like a simple concept but I think most people don’t operate that way.

    • Kevin says:

      It could be in part because people are just not wired to care about the long run that much. If most people I knew were dying in their mid-thirties (like was much of human history), I would be living it up, too!

      Show people the actual costs, though, and they might reconsider. Not everything is intuitive, but the great thing about us humans is that we can learn and adapt.

  9. Good post Kevin!

    To be honest, while I think about opportunity cost now and again, I don’t put too much focus on it. I figure I need to have a balance between living for today and living for tomorrow. Life is too precious to be always planning ahead. I enjoy my $4.00 Starbucks now and again, I simply wouldn’t do it every day or week :)

    As for your chef friend, good on them. I have a very good friend who was working as an IT consultant, and gave it up for at least 3 years because he wanted to be a golf pro. He pursued his dream, only to realize, there’s no money in being a golf pro unless you’re one of the best of the best. For every one pro that “makes it”, at least 1,000 don’t. Does he regret his decision? Absolutely not, not for a second.

    Opportunity costs should likely be considered, probably formally, for major decisions and situations. Otherwise, don’t opportunity cost the small stuff. I’m trying to get better at that everyday. I don’t want to woulda, coulda, shoulda my life away :)

    • Kevin says:

      There is a different balance for everyone. I believe that whatever level maximizes your life expectation is the level you should go for. I don’t believe in frugality for frugality’s sake, either. I do think that many of the people living “the easy life” today would change their minds if they knew what they were giving up, because they are not living a balanced approach. These people could learn from your example: they could learn that it’s possible to build up a nice nest egg and avoid a dismal old age, while still enjoying life!

    • Kevin says:

      Oh, about your golf friend: So long as he had the time of his life, then that contributed to his happiness and well-being. I know this is not conventional thinking, but I don’t believe that the purpose of school and work is simply to earn money. Money is important, but so is happiness and doing what you enjoy. Sometimes you sacrifice some of that to get more money, but you should only do so if you expect that money to give you greater happiness in the future (financial freedom, etc…)

      My chef friend has all the opportunities in the world, too, including paid international scholarships! Some people might think he’s a complete moron or absolutely insane,… and I do think he’s taking a big risk, but… it’s what he *loves*. If one day he doesn’t love it anymore, or it doesn’t work out, then at least he tried. He’s young enough that he has plenty of time to get back into the rat race if that’s what he needs to do some day. ;)

  10. Nicole says:

    Opportunity costs are near and dear to my heart. Preach on.

    Re: minimum wage… That’s difficult. With almost any government intervention there are going to be pros and cons. We don’t want powerless people (particularly adults– kids 14-19 can still be paid less than min wage in many states) to be exploited. Minimum wages take rents from companies with monopsony power and direct them to employees rather than profits (a la Card and Kruger).

    But yes, there are some situations where both parties would be better off with less oversight… The government figures that most of these training situations are for people under 20, so they allow for lower training wages for young people in the law.

    And maybe your friend would be offered a training wage, but they could just be saying that… he’s working for free now and there are a lot of wannabe chefs willing to work for free. The law allows for a lower training wage for people under 20, so if they’ve got any under 20 year olds and they’re getting paid a training wage, then I’d believe they would offer him one too. Otherwise…

    • Kevin says:

      I think that if my chef friend wants to negotiate a wage with his chef master (it does sound exploitative, eh ;)), a government bureaucrat should not stand in between them. My friend is not a moron, and if he wants to be “exploited”, he’s doing it because he feels his life will be better off. It’s a voluntary trade.

      I do feel for those stuck in min-wage hell, though are those people you mention really getting only minimum wage? I’ve done plenty of menial jobs including work at supermarkets, but I usually managed to get at least a dollar above minimum wage. My two jobs where I got min or below was when I was 12 as a paperboy, and 16 as a landscaper. That stuff was almost slave labour…. but, I had fun, and it was a good experience. ;)

    • Kevin says:

      Oh, I think the exceptions don’t apply where I live. It’s either minimum wage and above, or no job, starting from the age of 16 (you cannot legally work under 16; I think even the paper boy thing is illegal today).

      • Nicole says:

        There are different state rules about these things. In agricultural states, age 14 is allowed for farm work. Otherwise age 16 is standard. People are allowed to work for family businesses at a much younger age than that.

        The federal minimum wage specifically allows for training wages for people under the age of 20. You don’t like your state’s rules about that.

        Your friend wouldn’t be exploited, but history is full of people who would. Mostly women. There are trade-offs. Heck, without the minimum wage rules, your friend might not find being a chef so attractive later on because wages once he has full employment could be lower in the absence of the laws. (There’s a literature showing that companies set step wages based on the minimum because people care about relative wages… when min wage goes up, all wages go up.)

        Illegal immigrants are still exploited illegally and not given minimum wages. If there were more enforcement on that, those wages would be higher (and those services/items would be more expensive for US consumers).

        These issues are MUCH more complicated than just your friend’s situation. The general equilibrium effects are enormous. Yes, any time there’s government intervention there are trade-offs. Your friend is just one tiny part of that, and he might not like the alternative once everything filtered out.

        • Kevin says:

          Hey Nicole,

          I live in Canada, so the rules are somewhat different here. What we do have are tax credits for certain technical professions (I worked as a co-op student myself, and AFAIK while it was officially sponsored by the school, my salary was subsidized by the govt; in effect, I cost the company less than minimum wage). I don’t believe this applies to my chef friend.

          I don’t like to see those illegal immigrants exploited, either. Heck, in Canada we exploit the *legal* immigrants plenty! How do we do that? We refuse to recognize their foreign diplomas, so doctors have to become taxi drivers. If they don’t like it, they have to go through all of med school all over again. Do I think that’s fair? Not at all.

          I also recognize that these immigrants come here because they see our country as offering them a better opportunity than back home. The issue of illegal immigrants is a touchy one, but I believe that all people deserve a chance and that if someone wants to come to work and contribute, they should not be forced to do so under the table. Legislation that discriminates against all marginal workers, including the minimum wage, is detrimental to this goal. Everything has a cost, and raising the wages (by setting a price floor) does not come for free. Because of government laws against the freedom to contract, my friend does not enjoy any legal protections which other workers are entitled to, and I don’t feel that is right, either.

  11. Hey Kevin,

    There’s no minimum wage or welfare in Singapore. But the culture is one of Filial piety, extending beyond the parent/child relationship http://en.wikipedia.org/wiki/Filial_piety
    so family lean on each other when things get tough. My impression is that they think our reliance on individualism makes us weak–and they might be right.

    I think time spent doing what we don’t like is the biggest opportunity cost of all—-considering that life is the most precious commodity we have.

    • Kevin says:

      I think they might be right, too. Individualism that is achieved through force is not very healthy — replacing family with social security, replacing friends with welfare. Sure, you can go it alone when you have those nets, but there’s both a fiscal and a social cost to that.

      Not everyone has good friends or good family, but there are also charities, churches, and philantropic endeavours. I believe there is a huge quality difference between help given/received in aggregate or by force, and help given/received personally. It’s the difference between feelings of entitlement and resentment, and feelings of love & generosity.

      Of course, the filial piety thing can sometimes get a little stifling, too. Maybe we’ll come to a better balance through the merging influences of eastern and western culture.

      Finally, you are very right. I think my chef friend realizes this, even though he has so many doors open to him and scholarships, etc… available. I think he would be more secure at least finishing his degree (he only has 4 months left!), but if he really doesn’t like it, no matter how good he is at it, then perhaps his current path is the right path for him.

  12. Mike says:

    Hi Kevin,

    The idea of considering how we’re spend our time and money or at least stopping to consider if there is a better use for each comes down to what degree we want to take things.

    While I have always understood and appreciated things like ‘The Latte Factor’ by people like David Bach, personally I don’t like the idea of tracking every dollar to save an extra $50 at the end of the month. (That’s just a personal choice and hey, I like my Starbucks)

    I’d have to agree with Andrew and on a broader scale, that how we spend our time (specifically our daily working life) doing a job or career we don’t find fulfilling or that brings out our unique talents is the biggest opportunity cost of all. Once we align our working lives with our talents and passions, a lot of the other things seem to fall into place. Going back and forth to something we loathe just isn’t worth it, IMHO.

    • Kevin says:

      Haha, I don’t track down every dollar, either, but I have made various changes, like bringing food from home instead of eating out for lunch, and things like that. Once you’re aware of the tradeoffs, you can make better-informed choices.

      I think people shouldn’t be asking themselves “what will make me money” when they’re in school, but rather “what will make me happy and make me enough money to be content?”. If someone finds their passion then they can potentially be more successful and make more money down the road, anyways. Some people become doctors or lawyers because they genuinely love the field, while others only see the big bucks and don’t like many parts of the profession. For those people, entering med school would be a mistake IMO.

  13. Great post as usual, Kevin!

    I agree the opportunity costs should not be ignored. BUT I also think it is not good to always think about “just” the future. We should live a little now (and have a Double chocolate chip frappucino.) ok… ignore the frappucino that is not necessary, the point is we should think about the consequences of our every decision and be awake of what it might cost us in the future and then make a decision. If the decision is to forgo $100 in the future money to have a nice dinner with someone today, so be it… There should be a balance and that will be different for each of us, that is ok too… as long as we are happy with our decision and take responsibility for whatever action that decision brings us, we will be ok I guess…

    • Kevin says:

      Hey Suba,

      You’re quite right that we need to balance both the future and the present. I believe we need to balance both of them out so that we hit the best balance that gives us the most satisfaction. Sometimes, that includes $100 dinners every now and then.

      The important thing is that you are aware of what you’re trading off. If your $100 dinners are so often that you are not putting enough money away for your future, that actually hurts your overall satisfaction. You may be happy now, but you won’t be happy later on, and you probably gain less now than what you’re giving up in the future.

      So, the trick is to find that balance that sacrifices neither the present (extreme frugality) nor sacrifices the future (extreme consumerism). Gotta be aware of the tradeoffs and find that balance!

  14. When it comes to the minimum wage, it could be argued that it has dramatically reduced the availability of entry level jobs, and hurt teenagers seeking employment the most.

    • Kevin says:

      That’s not only the conclusion we’d expect to see on an economic level, but it’s also what I can see in practice.

      When would a minimum wage be justified? I suppose it could be justified were there only one employer and that employer was abusing their position (this reminds me of the Soviet Union).

      Of course, the employees could just form a union, instead. For all the bad rap that unions get today, they did have their place in our history. IMO problems come about only when the balance of legal power is in favor either of the union or of the employer. Neither should be favored and both employee and employer should have the freedom of voluntary contract and association.

  15. Squirrelers says:

    I’m a big fan of considering opportunity costs when making decisions. It’s often left out of the thought process, but it’s important to think about what else you could be doing with your time and money. Or health, for that matter. You want that order of fries? Think about the opportunity cost.

    Even when faced with a positive outcome, opportunity costs come into play. Businesses do this all the time; if Project A has a high NPV, but Project B has an even higher NPV, and there are limited funds and capital won'[t be raised, which project will get the capital? Project A will be bypassed, because even though it’s a good profitable project, there’s an opportunity cost that needs to be considered.

    I actually had a post involving opportunity costs in the very early days of my blog….of course, that’s when I had about 10 readers:)

    Good post and good discussion.

    • Kevin says:

      Haha. That’s a good point regarding the NPVs and the two different projects. Two different opportunities may be good, but one may be better than the other so you still need to make a choice.

      Have you tried out that Old Post Promoter plugin yet? How is it working out for you?

      • Squirrelers says:

        Kevin – haven’t tried the old post promoter plugin, I should do so sometime. Maybe then my own opportunity cost post could be more visible. Have a few others I like, which I’d like to introduce – or reintroduce more accurately, though I’m not sure how many saw them in the “old” days.

  16. Excellent post Kevin!

    I think if we thought in “opportunity cost” before we make a big purchase, it would help decrease people’s debt load. I suppose its all about instant gratification vs delayed gratification.

    Next time I make a big purchase I’ll make sure to critically think about opportunity costs.

  17. [...] Invest It Wisely: The Importance of Opportunity Costs and Why They Should Not Be Ignored – Kevin at Invest It Wisely has a great post about the cost of your decisions and the enduring effect on personal finance and government policy. [...]

  18. Das says:

    There are some good comments over here. I think a balanced lifestyle is way to go. Not spending too much and not being stingy. After all we all need to spend *wisely* to keep the economy going :)

  19. Mrs. Money says:

    I think some people don’t consider opportunity costs enough. I work full time but hate it. I can afford to go part time but won’t because I feel like I’ll be lazy. I feel like I’m passing up the opportunity to better spend my time :(

    • Kevin says:

      I think I’d feel like I’d be lazy going part-time too, but maybe not if I took that time to travel or if I worked at home from a home-office. Have you looked at getting out of the rat race? Jacob from Early Retirement Extreme has a lot of good advice there. ;)

  20. Joe Plemon says:

    Kevin,
    As usual, another great, thought provoking post. I loved reading the comment thread and have very little to add. Perhaps this: realize (as you said) that a variety of opportunities exist, then make your choice. Sometimes that choice may be to delay today’s pleasure for tomorrow’s benefit. But sometimes it is perfectly fine to take that $4,000 cruise instead of investing the same amount toward retirement.

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  23. DIY Investor says:

    Understanding opportunity cost is the first step in understanding economics. We think in terms of opportunity cost more than we realize. At the beginning of each semester I ask students how much it costs to attend the college. They say $110/credit hour etc.
    I point out that there are many who would be willing to pay that cost and don’t attend because there are other costs involved. The extreme example, of course, is the professional basketball player who would have to give up millions to attend. Closer to home is the man or woman who would have to pay for a baby sitter, or the worker who would have to step off their career path.
    If you’ve ever been in the situation of foregoing a vacation opportunity because it precluded you from getting a raise you were thinking in terms of opportunity cost.
    In economics we differentiate between explicit costs and implicit costs. Opportunity cost is the sum of both.
    Great post!

    • Kevin says:

      Thanks for stopping by, DIY Investor! We definitely have to take these costs into consideration, and be ready to look for the unseen, as well as what’s obvious before our eyes.

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  26. Kevin, I was going to write a post on this topic this week! But, you nailed it! Awesome!

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