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What is economists’ opinion of strawberry smoothies? You can also try kiwi flavors instead, as well as other options, It makes me think about opportunity costs.
In everyday life, what is the opportunity cost? In recent Page One Economics: Money and Missed Opportunities, Andrea Caceres-Santamaria, senior economic education specialist at the St. Louis Fed, defines opportunity cost as the value of the next-best alternative when a decision is made; it’s what is given up.
The Scoop on Scarcity
There is no such thing as having everything we want in life.
This is where scarcity enters the picture. A limited supply of goods, services, time, money, and opportunities confronts our unlimited wants.
According to Caceres-Santamaria, this concept drives choices and, by extension, costs and trade-offs.
She gives the example of purchasing a $7 smoothie at the mall.
The choice is often viewed as a simple one based on whether you want the drink or not.
In its place, she suggests viewing the decision differently by wearing “a unique pair of economist glasses”; she asks:
- What is the value of this to me?
- How much am I willing to give up to have it?
- How will I deal with this in the future?
Costs That Are Seen and Unseen
Costs That Are Seen and Unseen
It’s easy to focus on immediate financial trade-offs, but long-term trade-offs can affect more than financial well-being.
Thus Caceres-Santamaria encourages us to consider implicit alternatives, which are “unseen” opportunity costs, along with explicit alternatives.
This means looking beyond the present and assessing alternative uses for the money, otherwise known as not being shortsighted.
Another example of opportunity cost would be?
The night before an exam, a student spends three hours and $20 at the movies.
Time spent studying and money that could be spent on something else is the opportunity cost.
Wheat is planted by a farmer; an alternative crop could be planted, or the land and farm equipment could be used alternatively.
An employee relies on public transportation instead of driving to work.
It takes 70 minutes on the train as opposed to 40 minutes on the road. An hour a day is lost by not taking the train.
Is Opportunity Cost a Big Deal?
Losing study time and spending $7 on a smoothie might not seem like costly decisions, but what about the bigger decisions — like whether to buy a more expensive home than a starter home or to spend $1,500 more on an upgraded trim package for your next car?
When making higher-priced purchases, Acres-Santamaria explains, opportunity costs are neglected even more.
An individual considering purchasing a car might think about the relative value of a $1,500 upgrade compared with the base price of $18,500.
We might find it more useful to ask what else $1,500 could buy outright instead of comparing the configuration to the vehicle.
Why the Rush?
According to Caceres-Santamaria, most of our decisions regarding money are driven by immediate or sooner-than-later consumption.
Consumers value the thrill of consuming today significantly more than their thoughts of consuming in the future.
Our impatience is natural, tugged by the immediate gratification of a benefit rather than a payoff that may take years to arrive.
We’ve all read about the future value of money in retirement plan books or heard financial advisors discuss it. But seeing is believing.
The Future Value of Money
The Future Value of Money
Example 1: The one-time windfall
Take the example of a surprise windfall of $4,000 that you want to use to go on a getaway.
Sure, why not? There’s no loss to you because it’s found money – unless you consider the opportunity cost.
You could end up with $5,397 in 10 years if you instead invested your money in products that earned 3% interest, compounded monthly.
Five years from now, your funds could reach $6,270. Both examples do not account for inflation and taxes.
In terms of money, that’s the additional benefit. The earnings from your $4,000 in the future can also provide experiences that an extra $1,400 or more can provide.
Example 2: Small, regular savings over time
You can see how a single lump sum can be invested over time in that example.
How much does the daily purchase of your $4.49 caffè mocha cost you in opportunity cost?
Could you make more money if you invested that $54 per month instead of spending it?
You’d have $7,619 to dunk your doughnut into after 10 years if you dropped the coffee (be careful! ), invested $54 monthly and earned the same 3% annual return.
You don’t want to give up your regular mocha for too long? You would still save $3,554 if you cut the time frame in half to five years.
These figures do not account for inflation or taxes.
Especially when you consider that a $4.49 caffè mocha habit over time can dwarf splurging on a $4,000 getaway trip, these examples are striking.
Would you like to test some of your own opportunity cost what-ifs?
Consumers should avoid going into “autopilot” mode when making financial decisions, says Aceres-Santamaria.
Consider as many alternatives as you can to spending your money, even a pack of gum.
see more on: The Boo Money.
