What It Means
Opportunity cost is the value of the best alternative you give up when you choose one option. The St. Louis Fed describes it as the next-best alternative, so only the single best option you passed up counts, the one you'd have picked otherwise. It applies to time as well as money, since an evening spent on one thing can't also go to the next-best thing.
Try It: Find the Opportunity Cost of a Habit
Pick a habit's weekly cost and see one opportunity cost: what the same money could have become if saved. The return is only an example.
The saved total assumes each year's money goes in at the end of that year.
How It Sounds at Home
- "If I buy this, that's the trip gone."
- "Is it worth a whole Saturday?"
- "Every dollar on takeout is a dollar off the card."
The Breakdown
Worked example. Sam spends $25 a week on takeout lunches, $1,300 a year. The next-best use of that money, for Sam, is a savings accountSavings accountA bank or credit union account for money you're setting aside for later, which earns interest and is insured up to federal limits at insured institutions. See more. Using an example return of 4% a year:
| Years | Spent on lunches | Saved instead at 4% |
|---|---|---|
| 1 | $1,300 | $1,300 |
| 5 | $6,500 | $7,041 |
| 1010,000 stepsA popular daily step goal that began as the name of a 1960s Japanese pedometer; later studies find health benefits begin well below it. See more | $13,000 | $15,608 |
What the result means. The opportunity cost of the lunches over 10 years is about $15,608 of savings, more than the $13,000 spent, because saved money earns a return. If Sam's next-best use were paying down a credit card, the opportunity cost would be the interestInterest rateThe yearly percentage a lender charges for borrowing money, not counting fees; the APR adds certain fees to show a fuller cost. See more that card keeps charging. The number only counts the best option Sam gives up, so it changes with what that option is.
Keep it in proportion. A habit you enjoy can be worth its opportunity cost. Seeing the number lets you make that trade on purpose.
Good to Know
The St. Louis Fed's economics education materials stress that opportunity cost is the most highly valued option you give up, which makes it a personal number: it depends on what you'd actually do instead. The 4% return in the calculator is an example only. A savings account's rate is set by the bank and can change, and investment returns aren't guaranteed, so use your own account's rate when you run the numbers.
FAQ
What is an example of opportunity cost?
Spending $25 a week on takeout lunches means $1,300 a year isn't going to your next-best use, such as savings or a card balance. The value of that best alternative is the opportunity cost.
Is opportunity cost the value of every option I didn't pick?
Only the best one. The St. Louis Fed describes it as the most highly valued opportunity you give up when you make a choice.
Does opportunity cost apply to time as well as money?
Yes. An hour spent on one thing can't be spent on another, so the opportunity cost of that hour is the value of what you'd have done with it otherwise.
Do It in Buhata
Budget and repeating entries
Add a habit as a repeating expense in Buhata so its monthly and yearly cost shows up in Budget next to what you're saving for.
Open BuhataRelated Terms and Categories
- Sunk cost
Money, time or effort already spent that can't be recovered whatever you decide next. Letting it steer the next decision is the sunk cost fallacy.
- Needs vs wants
The split between costs you must pay to live, work and protect what you have (needs) and extras that would be nice to have (wants).
- Compound interest
Interest paid on your original amount and on the interest it has already earned, so each year's interest is a little bigger than the last.
- Savings goal
A specific amount you plan to save by a set date for one purpose, which turns into a monthly or per-paycheck amount to set aside.
Sources
Federal Reserve Bank of St. Louis, "Money and Missed Opportunities" (Page One Economics); St. Louis Fed, "Real-Life Examples of Opportunity Cost"; St. Louis Fed, "Opportunity Cost," Economic Lowdown podcast; Britannica Money, "Opportunity Cost"
- www.stlouisfed.org/publications/page-one-economics/2019/10/01/money-and-missed-opportunities
- www.stlouisfed.org/open-vault/2020/january/real-life-examples-opportunity-cost
- stlouisfed.org/education/economic-lowdown-podcast-series/episode-1-opportunity-cost
- www.britannica.com/money/opportunity-cost
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