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Opportunity Cost

Learn how you can spend money even if you’re not buying anything.

Everything you do has a cost.working out

What? How can hanging out at the park with friends have a cost? It’s opportunity cost. The thing itself doesn’t have to have a dollar amount associated with it, but it may not hold the same value as other activities. Maybe it’s getting your chores done. Or even sleeping.

How do you figure out the opportunity cost of something? Some of it is up to you. You must think about the value of different events. Take sleep for example. Sleep is extremely important, but maybe you haven’t gamed with your friends for a few days. Now, catching up with friends is great, there is a lot of value in it. However, if you stay up late, you could sleep through your alarm and miss work in the morning. There is a cost to that. You lose money, or possibly your job.

The cost comes in two forms, explicit and implicit costs.

Explicit costs: This is the actual dollar amount you lose. In the example above, that would be lost wages or the cost of whatever you’re doing.

Implicit cost: This is the money you’re spending because you’re using your resources or you’re doing something that keeps you from making money or jeopardizes your ability to make money.

In the example from before, you have no explicit costs, but you do have a lot of implicit costs. Staying up late means you could be too tired to work. If you make it to work, you could perform poorly. If you perform poorly, you don’t get a raise.

It might be hard to estimate the cost of something when it has no explicit cost. You have to decide on the value of what you’re going to do and take into account any possible consequences that may come as a result.

That isn’t an easy task. A tip to deciding the implicit value of something is to think about any impact it may have on the future. Driving around town with your friends has a low explicit cost and a low implicit cost. But if you decided to try racing, you just increased your implicit cost. If you get pulled over, you’ll get a huge ticket. You could wreck your car. Both of those are going to increase your insurance costs.

A few other tips to decide the implicit costs:

  • What are the possible long-term effects?
  • Are you neglecting responsibilities to do it?
  • Could your actions lead to injury?
  • Are you risking destroying something expensive?
  • Is it illegal?

All of those are things that could drastically up the cost of what you’re doing. As mentioned, driving with your friends is fun. Drag racing is fun, but it is also illegal outside of sanctioned events. If you get caught, you’re going to have to pay. A lot.

Something like going to the amusement park with your friends also has implicit costs. You might only look at the price of the ticket to get in, but there is gas, parking, food, time off work, and other costs inside the park.

So next time you’re planning to do something, think about the opportunity cost of doing it. Both the explicit and the implicit costs. Weigh your options and choose wisely. Making money isn’t all about being at work. And saving money isn’t all about putting dollars into your credit union account. Everything you do has a cost at some point; it sometimes just happens to show up later than you’d expect.