Opportunity cost

One Sunday each quarter, the California Academy of Sciences is free to visit.

California Academy of Sciences Rainforest

Or is it?

You don’t have to pay for admission, true. But since the event is both infrequent and well-known you’ll need to wait in line for, say, an hour and a half, even if you show up before they open the doors. How much do you make per hour (after tax)? If more than $20, one could argue that you’re losing money by standing in line instead of just paying $35 for entrance on a less crowded day.

Of course it’s not quite that simple; many people couldn’t simply work 1.5 hours more if they needed extra cash. And you might have been having fun with your friends while waiting. Though on the other hand the crowding doesn’t end once you get inside, so arguably your experience of the museum is inferior as well. But the point is that we ought not to compare expenses of time/money to doing nothing, but rather to what we could have spent it on instead.

The term used to describe this in economics is opportunity cost, as in the value of the opportunity you gave up through a given choice. And the concept is particularly important in situations like the above where the explicit cost of a choice is zero. You may have heard the phrase “There ain’t no such thing as a free lunch” from either Milton Friedman or Robert A. Heinlein, and the point is that there is an opportunity cost to everything.

The clearest example of opportunity cost might be a game show where you give up a sure reward for the chance at a larger reward. The choice to gamble isn’t free, because if you’d declined you would have gained something. And the same principle holds throughout our actual lives: Going to the movies doesn’t cost $12, but $12 plus two hours that you could have spent reading a book or learning web design. Eating dinner at Chipotle doesn’t cost $8, but $8 minus whatever you would have spent to cook at home (assuming you’re not skipping dinner). A free chair on craigslist will still cost you gas to pick up.

Of course it’s possible to get a bit carried away: I’ve heard it said that we shouldn’t ever do something if someone else can do it for less than we make per hour. Sure, specialization is a foundation of modern society, but if you only have a single skill you’d better hope that demand for it never drops. And it would be naive to imagine that we could actually calculate the precise opportunity cost of anything when the “cost” could include anything from hormonal imbalance to the respect of others. Nevertheless, I don’t think the importance of understanding opportunity cost can be overstated if you want to efficiently pursue your life goals, whatever they may be.


Thanks to Johan Larsson for engendering this post with a question about opportunity cost.

 

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