Opportunity Cost

by Jeremy Powers on June 16, 2010

Weighing opportunity costI found an article over at The Best Article Every Day entitled “12 Important Financial Concepts You Didn’t Learn in School.”  One of the 12 items reviewed is opportunity cost.  Let us review, via a quote from the article, what opportunity cost is:

“Opportunity cost refers to the value of your foregone options. The opportunity cost of attending college, for instance, might be the income you could earn at a job if you weren’t in school. The opportunity cost of going to a party might be a lower grade on the test because you didn’t study. Every choice in life, big and small, entails opportunity costs. Nor are they always this obvious. Many “do it yourself” projects are actually a waste of time and/or money when opportunity cost is considered. Let’s say it takes you six hours to do your own taxes, during which you cannot work on your business. If six hours working on the business would have produced more than the cost of an accountant, doing it yourself was a waste. . . .”

While several of the concepts found in the article are frequently mis-understood, opportunity cost is one of the most commonly unconsidered realities in very small companies.  Any small business owner billing $50+ an hour, but who still comes to work on Sunday afternoon to “catch up on paper work” is failing to understand opportunity cost.  If a book-keeper can perform that work for $30 an hour (and probably in fewer hours) then you are costing your business by refusing to contract the work.  More to the point, how much does a divorce and bitter children cost these days?

This is also a consideration when evaluating assets.  A quick story:

Business Owner:  “Well it took some doing, but I saved $70 on my printer.”

Jeremy:  “How did you do that?”

Business Owner:  “I have been keeping an eye on the prices of this model for weeks.  Then I finally decided to check that huge computer discount store on the other side of town.  They had the model I wanted for $70 less than anywhere else!”

Jeremy:  “So after weeks of searching, you drove two hours out of your way just to save $70?  Remind me, what is your hourly rate for service calls?  $65?”

If you have good examples of when you failed to consider opportunity cost, I would love to hear them in the comments.  Your story might prevent other readers here from making the same mistake.

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{ 2 comments }

sara

Actually opportunity cost is taught in Ohio schools now in 3rd grade. It is a state standards that 3rd graders be able to identify opportunity cost. They know that opportunity cost is something that you want that you give up in order to get something else. I have had them write stories that are examples of opportunity cost. Just saying…

Jeremy Powers

Great to hear it! Unfortunately, a lot of life happens between third grade and the day you run a business. I remember learning it was “not nice” to pinch girls’ butts in third grade, but there are so many lessons we learn in third grade and forget as we grow older. . . .

Most business owners could learn a lot from the simplicity of third grade teaching. We tend to over-complicate. Keep pushing your students. The teachers I respect the most now are the ones I loathed when I had them as teachers.

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