I’m going to give it to you straight…
Economics is so confusing.
Even the smallest economic principle is a migraine away. Looking up what opportunity cost is was an adventure in itself.
Wikipedia’s explanation was like reading an academic paper. In 30 seconds, you’re reaching for the nearest sharp object to stab into your head.
The next explanation was a little better. After the third and fourth explanations, I finally figured out what it was.
Frankly, I had to dwell on it for a day.
For most Americans, they don’t have a day. If it’s too complicated to understanding, then they’re gone. And frankly, I don’t blame them.
I don’t blame you for not knowing what opportunity cost is. Heck, I didn’t know until yesterday.
It’s confusing. Like, a lot.
But not this article.
Economics is actually pretty simple. It’s the economists who make it complicated. Mostly because they can’t explain it without using buzz words and insane terms for ordinary words.
Well, here’s your no nonsense guide to learning what opportunity cost is, and how it applies to your life. Shall we begin?…
What is Opportunity Cost?
Simply put, opportunity cost is the next best thing you could have done with your money and time.
Say you’re going to spend your money and time on option “A.” The opportunity cost is the money and time you’re spending on option “A,” plus the enjoyment you’re missing by not doing option “B.”
Opportunity Cost is way of analyzing available choices. You have limited resources (i.e. time and money), you can make one of several choices, but you only have enough resources for one choice.
Which do you choose?
Choosing option “A” over options “B” through “D” means you’re missing the value that those options provide.
Opportunity Cost is what you’re missing out on by making a choice.
Why is it Important?
Ok, I bet you’re wondering why in the world this is important. It’s just confusing economics, right?
This economic principle is key to understanding not only individual life choices, but choices the government makes with your tax dollars.
With Opportunity Cost, you can see (and understand) the effect choices have on your life.
This is especially true with college…
What Does it Have to Do With College?
College is the stairway to heaven. It provides Americans with an education that practically guarantees them a high paying job and a great life. College is part of the American Dream.
…or, is it?
Just like any decision you make in life, there’s an opportunity cost associated with it. I’m writing this article, which means I’m not playing video games, listening to a podcast or reading articles. I’m giving up other things to do this.
You have to give up a lot to go to college. Whether you think about it or not, the opportunity cost for college is immense, and it might be hurting you.
College Costs A lot (and I mean A lot)
The average costs for college ranges from “$30,094 at private colleges, $8,893 for state residents at public colleges, and $22,203 for out-of-state residents attending public colleges” for one year of tuition.
That’s a lot of money either way. Also, remember the tax payers who are subsidizing your $8,893 state college education. Nothing is cheap when it comes to the government.
In fact, college costs a lot more than you’re led to believe. This is where opportunity cost comes into play. Here’s an example David R. Henderson, from the Library of Economics and Freedom uses to explain the opportunity cost of college…
Take a student who annually pays $4,000 in tuition at a state college. Assume that the government subsidy to the college amounts to $8,000 per student. It looks as if the cost is $12,000 and the student pays less than half. But looks can be deceiving. The true cost is $12,000 plus the income the student forgoes by attending school rather than working.
If the student could have earned $20,000 per year, then the true cost of the year’s schooling is $12,000 plus $20,000, for a total of $32,000. Of this $32,000 total, the student pays $24,000 ($4,000 in tuition plus $20,000 in forgone earnings). In other words, even with a hefty state subsidy, the student pays 75 percent of the whole cost.
The true cost of college is the tuition, plus outside expenses, plus what you could be making if you weren’t in college.
What Could You do With the Money You Spent for College?
Instead of going to college to study photography, could you be out in the field actually taking pictures and learning under a professional?
Instead of going to college, could you be working full time, saving up money for a car?
The possibilities are endless.
I know that I’ve given a lot of thought to my own college experience. What could I be doing I wasn’t going to college? Well, I could…
- Be working more hours
- Save up to buy a car
- Grow and expand The Political Informer
- Put more focus toward writing
- Get on my way to living financially independent
- Not have to deal with school projects
I’ve thought about it. Trust me, I have. The opportunity cost is real in my life. That list is a small part of the opportunity cost associated with me going to college.
What You’re Doing Vs. What You Could Do
Opportunity Cost is all about what you chose to do verses what you chose not to do.
You can spend an excessive amount of time and money at college. Or, you can buy a car, start your career early, and get on your way to becoming financially independent and stable.
You can go to the movies, or enjoy a good book while sipping coffee at Starbucks. The opportunity cost of going to movies is that you’ll be paying $10+ to see a movie instead of enjoying yourself at Starbucks.
Isaac at the Foundation for Economic Education (FEE) put it well…
Since I can only be in one place at a time, the choice to engage in one activity means I give up the others. But since I couldn’t pursue all the other choices at one time either, my opportunity cost is only the value of the next best alternative, as determined by my own subjective preferences.
I can either go to the movies or to Starbucks. My next best alternative is going to Starbucks. To another person, the movies is the next best alternative. And, to another guy, Starbucks isn’t even in the scenario.
It’s a mixture of subjective preference and an objective reality. You only have so much money to do things. But, you also have your own ideas of what is pleasurable and what’s not.
One Last Example: Government Spending
Like college, government spending is a great example of opportunity cost at work (or, not at work depending on how you look at it).
Politicians and lobbyists are always saying the cost of helping the poor or providing healthcare is irrelevant.
Helping people is so important that we need to forget the cost that comes with it.
This type of thinking is dangerous, especially when it’s the government.
If something is so important that cost is irrelevant, it means that other important actions get left behind. If a politician says two or more things are so vital that cost is irrelevant than you’ve hit a conundrum. Dwight from FEE makes this obvious…
As soon as two or more groups claim that their program should be funded without considering costs, the relevance of costs should be obvious. Educating our youth and curing our sick cannot both be too important to consider cost, not in a world of scarcity. The cost of doing more to educate our youth is doing less to cure our sick, and vice versa. To ignore the cost of one is to treat the other as unworthy in comparison.
If anyone needs to understand how opportunity cost applies to everyday life, it’s politicians in Washington.
Passing one program means you can’t focus on another. Involving yourself in wars means that money can’t be spent on domestic projects.
And most importantly, spending an excessive amount of money on any government project means that Americans have less money to spend on the things that matter to them.
The opportunity cost for every government project is that more money is pulled from the private sector. Money that could be used for charity, cancer research, better education, a house that doesn’t leak when it rains, or a new pair of shoes for your son.
Politicians don’t realize the people they affect when they spend money.
To sum it all up, I’ll go through the main tenants of what Opportunity Cost are…
- Opportunity Cost is the money you spent on going to the movies, plus the pleasure you missed by not going to Starbucks
- It’s subjective (the pleasure you sacrifice) and objective (the money you spent)
- It’s a what you’re doing now vs. what you could be doing principle. You can’t go to Starbucks if you’re spending your money and time at the movies
- It’s based on the reality that you have a limited amount of money and time to do what you want
- It’s based on choice. You have to choose between different options and how much pleasure they bring
Whether it’s going to the movies, paying for college, or spending taxes on government programs. Opportunity Cost applies to it all.
It’s a great in helping you realize the effect of making choices in your life. It also helps you analyze the value that each choice brings.
Here’s a little fun experiment to do after reading this article. Pick an expense you’ve made (or are making) and find the opportunity cost of it. I already did it above with my choice to go to college.
You could do it with college too. Or, you could do it with your new car purchase, getting married, staying up late night after night, or your next video game purchase.
Pick an expense or activity. Find the monetary cost of doing it. Make a list of what you could be doing with that money and time. Then find the lost pleasure in doing that thing over the next best alternative. Compare it. Finally, think about the choice you made, and ask yourself if it’s the right one.
Be sure to share it in the comments below, or email it to be if you’re an Informer.