Opportunity Costs

An opportunity cost is the loss you will suffer if you do one thing over another. That cost could be zero, or it could be negative (that is a net gain by doing A rather than B) or positive (that is, a net lost because you did B rather than A). Opportunity costs exist because you can only do one thing at a time.

The loss or gain doesn't have to be economic either. Making a decision could have non-pecuniary impacts that compensate for financial losses or gains, either pro or con. Taking a better job might mean a move to a different city where you won't see your friends every day. Or reducing your hours to part time may cut your salary but you might get to spend more time with your kids, or pursue a hobby, or start a business, none of which you could do before.

Here's the way opportunity costs work. Let's say you have two choices. Each of them is full time so you have to pick one or the other. Choice #1 is a volunteer position that lets you do exactly what you want to do but pays nothing. You have enough passive income that you won't go broke if you take it. Choice #2 is a high level position in a very good company that pays well and offers benefits but is not really what you're interested in.

What do you do? Do you do what you want to do but not earn anything, or do you take the job that pays well but isn't what you what you want to do.

Imagine two alternative futures. Future #1: you take the volunteer position. After a few weeks you get talking to a senior executive of a large company who says they're looking for someone like you and asks would you consider taking the job. You interview and are hired making almost as much as the job you didn't take but with better benefits and doing pretty much what you did as a volunteer but comes with a good salary and benefits. You still get to work with the organization you were volunteering with.

Future #2 is, you take the job and are earning very well. Three months later the company is bought out and you are outplaced. The volunteer job has been filled and you're out of luck. Six months down the road you still can't find a job.

Choosing the volunteer job had a severe short-term opportunity costs because you chose the unpaid position over the salary. You might have decided that the benefits outweighed the costs though. Long term, choosing the volunteer position had strong negative opportunity costs because you wound up with a really good job out of it which paid you well.

Choosing the salaried job had high negative short-term opportunity costs because of the salary, though the things you didn't want to do that you had to may have undercut that a little. But long term, taking the paid job had high opportunity costs because you didn't do the other thing.

The "true" costs are impossible to measure accurately in virtually every case because we only have one shot at things and we can't rerun our lives to see how things might have turned out differently. But they give us a language we can use to talk about what we have done and are going to do in our businesses.

Go to Wikipedia and look up "opportunity cost."

Entrepreneurship is the life's blood of all my professional activities. It makes them go. And go read my mystery for free at wwww.kearneymusicschoolmurders.blogspot.com or buy it from Amazon.com more cheaply than you can print it out.