As its name suggests, opportunity cost refers to the cost of choosing one opportunity over others. This “cost” reflects the value you could have gained in all the options you didn’t pursue. It’s a helpful concept to keep in mind with complex decisions as it can highlight the comparative value of all our options.
Guiding our choices
We often have to choose between different options when making decisions. Some of these choices are small, like what to eat for lunch or what movie to watch on the weekend. Other choices are much bigger, like what field to study, what career path to follow, or where to donate.
A common mistake people make in these decisions is to focus on the value of a specific option that looks good at first glance, without considering the value of other available options. Opportunity cost is a helpful concept for guiding our choices in light of this.
Real world example
Let’s say you have some money to donate and you’re deciding between two charities. When you eventually decide to give to charity #1, the charity you didn’t choose will lose the value that your money could have provided. Of course, this is an inevitable tradeoff of making any choice. You can’t donate everywhere, after all, and it’s a good thing to give any money at all, right?
Well let’s say this other charity #2 is much more effective than the one you chose. In fact, it’s so much more effective that your donation would save a dozen lives at charity #2 but only a few at charity #1.
In this case, your choice to donate to charity #1 comes at the cost of the impact your donation could have had at charity #2. Ultimately, this means that fewer lives are saved and the opportunity cost is quite high. Even though donating anywhere is better than donating nowhere, the difference between these two charities can lead to significantly different outcomes – making your choice less good than it initially seemed.
As this example illustrates, accounting for opportunity cost can help us understand the comparative value of our available options and spend our time, money, and effort more effectively. This is particularly important for avoiding spending limited resources on an option that seems attractive at first, because it has positive expected value, but will actually give you much worse value than another available option.
Assessing opportunity cost
To account for opportunity cost in practice, you can go through the following basic steps:
- Figure out which options are available to you.
- Determine the overall value of each option.
- Compare the value of the different options.
When to consider opportunity cost
Beyond donating money, there are many other situations in which you could benefit from considering opportunity cost. For example, when choosing which cause to work on, you might realize that you can have a much greater impact working on one cause than on another, because of some comparative advantage that you have, such as a unique skillset. Similarly, when choosing what to spend your time on at work, you might realize that although getting a certain certification could help you build career capital, the time you spent on this could cost you valuable networking time. If it turns out that networking is more valuable to your career than the certification, the cost of losing networking time may not be worth it.
When trying to consider opportunity cost, you might encounter some obstacles – like uncertainty regarding which career path will be more impactful. When this happens, you can try to do things like talk to relevant people in order to gather more information. But, even if these obstacles mean that you can’t make a perfect decision, you could at least make a more informed decision by considering opportunity cost. When doing so, you can benefit from also considering other factors to help guide your decision, like counterfactual impact and neglectedness.