What are 'Opportunity Costs'?
““Intelligent people make decisions based on opportunity costs.””
What are ‘Opportunity Costs’?
‘Opportunity costs’ is a term from economics and refers to the penalty or ‘costs’ associated with choosing one thing over others.
‘Others’ is the operative word here because when you decide to do something, it means you have to rule out everything else. I.e. all ‘other’ opportunities.
Put another way, whilst it’s possible to do anything, it’s not possible to do everything.
Therefore, choosing to do one thing means you can’t do the other things you could have done.
To give an example, let’s say you are considering further study.
In this scenario, the ‘opportunity costs’ would include things like:
The salary you would earn if you continued working.
The business you could start with the money you're allocating for your studies.
The income you could earn from investing this same money.
The year travelling abroad you could take.
Another example would be spending your money; buying one thing means you can’t purchase something else.
Or choosing one career over another; studying medicine means you give up the opportunity to be a lawyer.
Why is it helpful to know about ‘Opportunity Costs’?
If you think about it, every decision has an opportunity cost.
This isn’t a big issue for trivial matters.
However, it’s a valuable exercise to consider your opportunity costs when making significant decisions.
Why?
The answer is that we tend to think only of the positive consequences of making a decision.
However, what we’re ‘giving up’ (i.e. the opportunity cost) can sometimes be of greater value than what we believe we will gain.
By stopping to think through all available options, you may stumble upon a better use of your time.
The more successful you become, the more important understanding this concept becomes.
This is because the value of your time increases, which means you should be spending it on activities with the most leverage.
Where can you learn more about ‘Opportunity Costs’?
You might find this article from Investopedia helpful.
Even though it's about much more than just opportunity costs, the excellent book The Joys of Compounding: The Passionate Pursuit of Lifelong Learning has some good content on this topic.
