Tan cat looking out window from behind

When I was going through university, one of the concepts that I learned in economics class was opportunity cost. The idea here is that you can measure the cost of an activity relative to what you are not doing as a result. Let’s illustrate this with a simple example.

I Want an iPhone 5

Say, for example, that you want to line up to buy the iPhone 5 this Friday. For the sake of simplicity, we’ll say that you are buying the phone outright without a contract subsidy, so the 16GB model is going to cost you about $700. However, that’s not the only cost involved. You have to remember that time is money. Perhaps you need to take a day off from work in order to line up for the iPhone and, hypothetically speaking, let’s say that a day’s wage for you is $200.

Given that, the cost of the iPhone 5 isn’t $700. It’s really $900, because you are sacrificing the $200 you would have earned if you went to work instead. But what if we took this hypothetical situation even further?

The Costs Are Adding Up

What if, on that very same day, your boss was going to give someone a new project and this new project would come with a substantial pay raise. If you were at work, let’s hypothetically say that your boss would have chosen you. However, since you were lining up outside the Apple Store instead, your boss shifted his gaze to the guy sitting at the desk next to yours. Let’s call him Jim. Let’s say that, because you weren’t there, your boss (consciously or unconsciously) chooses Jim to head the new project.

Let’s say that, if you were chosen for this project instead, you would have earned an extra $10,000 this year. If that were the case, then suddenly that $700 iPhone has turned into a $10,900 value when you factor in opportunity cost. That’s one expensive smartphone.

But Opportunity Cost Only Exists If…

These are all hypothetical circumstances, but there is one very important lesson to take home: opportunity cost really only exists if there really is an opportunity for a suitable alternative.

Let’s use the example of watching television. If there are two programs that you want to watch and they happen to be at the same time, you would think that the opportunity cost of watching Show A is that you won’t get to watch Show B. However, if you have a dual-tuner PVR, you could be watching Show A while recording Show B. In this case, the opportunity cost (in the context of which show to watch) is essentially nullified, aside from the fact that you’ll just have to watch Show B later.

Another example is the cat at the top of this post. He’s staring out the window when he could be playing outside instead. That’s an opportunity cost, right? But what if the doors are all locked and the owner doesn’t let the cat outside anyway? There is no real opportunity to play outside, so that opportunity cost is nullified too.

The Big Picture

This becomes more complicated if there is only a small “window” of opportunity, so to speak. When many people talk about the cost of higher education, they talk about the cost of a student loan, the cost of the tuition, and so on. They sometimes forget the opportunity cost of pursuing a career at the same time. What about the lost wages? The lost work experience? The lost seniority that would have been gained? I’m not saying that higher education isn’t “worth it,” but opportunity cost must be considered.

The same can be said about professional exploits, your personal activities, and just about everything else that you do in life. By choosing to do one thing, you are effectively not doing any of the other possible things at that particular time.