Think About Costs, Not Just Prices
“Opportunity cost” is how economists describe the value of something in a situation where you have to choose between different options with only limited resources.
For example, imagine you have $10 in your pocket and you have a choice between going out for lunch with your co-workers or being able to take a cab home instead of walking 5km in the middle of January. You only have $10 in your wallet, so you have to choose one or the other — you can’t do both.
If you go out for lunch, then walking home in the bitter cold is your opportunity cost. If you take a cab home, then your opportunity cost is the pleasure of lunch with your co-workers. Because your money is limited, every decision to spend comes with some opportunity cost.
Rather than thinking about the price of your purchase in the abstract, thinking about opportunity cost helps you put the value of that purchase into context.
- Some people like to think about purchases in terms of the amount of hours they’d have to work to pay for something. For example, if your after-tax income is $10 per hour, then the opportunity cost of that $200 dollar pair of designer jeans is 20 hours of work.
- Other people like to think about purchases in terms of things they won’t get to do or buy. For example, that daily $5 you spend on a coffee and muffin before you get to work has an annual price of $1,300. Depending on your priorities, the opportunity cost of those purchases might be a well-deserved vacation or having money available for car repairs.
Either way, seeing opportunity costs helps to remind us that our dollars are limited and that every purchase is a decision. Thinking about the things we’re giving up to make a purchase is a powerful way to curb unnecessary spending.