Opportunity Cost — Living on a Budget
For anyone who has attended at least one lecture of high school or university level economics, the term opportunity cost should sound familiar. Opportunity cost is the value of the next best alternative that has been forgone. It is an economic theory that is used to describe the consumption behaviours of individuals and ultimately why we make certain choices on how to spend our money and time. Check out this link for an even more detailed description of opportunity cost.
To illustrate from a business standpoint, the opportunity cost of investing $100,000 CAD for 27% equity into an IoT startup would be a $100,000 investment for shares of a public corporation such as Nvidia. Of course both investments may yield a return, but the potential return on investment into Nvidia is in itself a cost, as you have sacrificed that for your venture into the IoT startup industry.
OK, now envision how you can apply this concept to your life.
You are a firm. You have capital in your bank account, and you have limited time. You are constantly making decisions on what you should invest your money and time into so that it gives you the greatest return, just like any corporation. So what if we put a real monetary value on your time and the items you purchase?
Let’s say you are a 4th year university student and you really want to try cocaine the night before your investment banking analyst job interview at Goldman Sachs. OK, understandable, you are in your 20s and you are stressed. But let’s think about this rationally. What is your monetary value on trying cocaine? Well it is not the $45 CAD you spent purchasing the gram but rather how much you value the 45 minute experience… let’s say $96 CAD as it is your first time. But then you must consider the opportunity cost. The next best alternative to you trying cocaine that night was preparing for your interview. Well instead of spending those 3 hours in the night preparing, you were high and thus did not get the job due to your lack of focus in the interview. So the opportunity cost of trying cocaine was your investment banking analyst job which is $115,957.76 CAD annually on average at Goldman Sachs so yeah… wrong decision buddy. I mean you would have had to work 100+ hours weekly so I guess you dodged a bullet there.
Obviously, that’s putting it into simple terms but the important point is, your opportunity cost exceeded your marginal benefit, thus it was a terrible decision. Make decisions that give you the greatest marginal benefit.
As an economics student, I constantly live in this state of overthinking because of this idea of opportunity cost. However, overthinking is not a negative habit in choosing how to spend your time and money because firms are profitable, the average person is not. You should not let your emotions or a price tag dictate your life and spending habits, instead assess it based on what gives you happiness and put your OWN price tag on items and your time. Check out this great video by Matt D’Avella on how to improve your spending and happiness.
Living in downtown Toronto is very expensive to a university student on a budget. I am constantly burdened with choices, should I eat out with my friends today? should I go to lecture today? should I study tonight? should I even go to university? Well, here’s my advice on how you can apply the very necessary concept of opportunity cost into your life.
When choosing between going out with friends to eat versus staying inside by yourself and cooking, do not compare the $20 meal outside to the $5 meal inside, think about this. What is the true value you place on being around those specific friends, the delicious new meal you get to enjoy, and getting to show off the fact that you have friends and eat good food on social media? Compare that to, would you rather use that $20 to buy another item that will give you more joy, do you really value being around those people or would you rather be by yourself, do you really want to take the effort to cook today? Evaluate who you are, what brings you joy in that moment, and then see which outweighs the other. It’s quite simple once it becomes a habit.
From then on you can make even bigger decisions such as would that $9000 CAD be better spent on other things other than residence? or is the value you get from being on or near campus without a commute greater than $9000 CAD? And will that annual $7000-$19000 CAD invested into your education yield a greater return in a potential career or would it be better spent investing it into stocks or a business while saving 4 years of your time.
I understand, it is impossible to place a monetary value on each decision you make and each hour of your time as it varies due to multiple undefined variables. The message I am trying to spread is that you can start putting more thought into the use of your time and money. Look beyond the price tag and invest greater thought into true value of each purchase while considering the opportunity cost. The more thought you start placing into your small everyday spending habits, the more accurately you will value your items and your time, and eventually, the more rational of a person you will become.
And as always, do not try cocaine.
