In simplest terms, opportunity cost is about lost value that comes from making one decision over another. A variation of cost-benefit analysis. Usually it’s about monetary loss, but there are opportunity cost examples that involve emotional or other types of personal loss.
While we can usually identify the basic costs involved in our choices, sometimes the full range of costs is not as obvious. You’d really need to think about all obvious and less obvious costs related to each possible path to get the full picture.
Opportunity cost examples
With a bit of fun in some of the following examples, I hope this helps clarify the idea further. If you go in one direction, what might you be losing and/or giving up instead? It’s not something we always think of, but there are real costs to almost any decision involving more than one choice.
Example #1 — Buying a house
When you apply savings to a down payment, the opportunity cost is the amount you’re not earning in interest on what was previously invested. And then of course there’s mortgage interest and upkeep. But also potential dollars gained when selling — if any.
Why does this matter? It helps to think about comparative opportunity costs when doing a thorough cost-benefit analysis of whether buying is actually a wise investment decision. Can renting turn out to be better at any given time in our lives or in the relevant economy / rate climate?
If you can invest the down payment elsewhere and do really well, renting may wind up being a better choice financially. This is especially true when you factor in all the repairs and extra costs including taxes of owning that you never imagined. And if rents aren’t way out of whack with real estate prices.
Example #2 — Buying a new iPhone
Another more familiar opportunity cost example can be applied when you buy that new iPhone. You won’t be able to use that money for something else — like an even newer iPhone as soon as that’s announced. Of course, if you have endless money, you can have endless iPhones, something Apple would love.
But whenever you buy something pricey, especially if you’re on a tight budget, there is a potential opportunity cost. Where else could that money be used that has benefit to you? Plus, you lose whatever interest you might have earned from savings if you bought nothing. And you lose the opportunity to teach yourself to stop buying so many tech gadgets!
Example #3 — Marrying Larry instead of Bobby
After dating both men for a year, you decide to marry Larry instead of Bobby. You have more than one opportunity cost here. First, you give up the chance to marry Bobby — at least this time. But by dating the one you no longer want for so long, you gave up the opportunity to try out Steve during that year.
Other opportunity cost examples
Just to add a bit more to the discussion, here are a few more everyday life situations where doing an in-depth analysis may be worthwhile. Or not. You decide!
- Going to college as soon as you can vs getting a job right after high school. A job gives you money right away and a chance to build your career vs taking on big loan debt or paying dollars today for a degree you hope brings greater future value for your career. Of course, college also offers more than a degree.
- Credit cards which give you use of the money right away while incurring fees. Plus that money will have to get paid off and you wind up paying more in the end. As with a casino, the bank wins all the time — as long as the borrower pays off eventually. (Casinos pretty much always get your money in the end.)
- Pay someone today for a car that they will give you in six months. Meanwhile, you have no use of the car or your money and the seller has use of your money — and the car. You have hope of a car.
- “I’ll gladly pay you Tuesday for a hamburger today.” (Wimpy from Popeye where the lender if suckered into it gets no real value and Wimpy gets it all!)
- Going to a Chinese restaurant vs Italian restaurant. As simple as that sounds, you are giving something up by choosing one over the other. And depending on your digestive system, you may be getting unintended returns.
A few more thoughts
I hope those opportunity cost examples were useful in helping you understand the topic better. Although I did include some fun examples, the idea can be worth thinking about when making difficult decisions.
But in the end, sometimes what tips the scale in one direction over another may be “utils” — or the level of satisfaction or utility a choice brings you. In economics it’s that hard-to-quantify value that makes one choice a better one for YOU.
That doesn’t mean you should simply give personal utils the greatest weight and just forget the rest. But in any decision there is always a special extra something that probably needs to be given at least some say in the matter!
More posts to help
Basic Financial Terms: Know Your Finance Lingo!
Credit Basics: What Do All Those Credit Terms Mean?
How Much Should Mortgage Rates Affect Buying a Home?
When To Use Saving To Pay Off Loans (And When Not)
Retirement Math: Why Saving Money Now Matters So Much
Why Can’t I Save Money Even When I Try?
Saving Money Is Hard. I Feel So Deprived!
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