Make the most of your Choices - Understanding Opportunity Cost

Welcome to Motivational Monday.

In today’s newsletter, I want to discuss ‘opportunity cost’. We all face opportunity cost in our lives and it is often impossible to avoid it.

What is Opportunity Cost?

Opportunity cost is easier to explain with an example. Imagine you are an 18-year-old school leaver deciding your next steps. Let’s say you are considering two options:

1. You have been offered a job as a receptionist in a local hotel, with a salary of 1,200 Euros a month before tax.

2. You can pursue (do) a 3-year degree in hospitality at a local University. You can live at home and your parents will pay the tuition fees. The local hotel has already told you that at the end of the degree, they will accept you as a graduate trainee scheme and the pay would be 1,800 Euros a month before tax. They have also told you that you should make junior manager within 5 years and senior manager within 10 years.

Opportunity cost is the value of action that you do not choose when choosing between the two possible options.

In the example above we can consider opportunity cost in 2 ways:

1. If you decide to work straight away as a receptionist, the opportunity cost is the difference between the salary you would receive as a graduate trainee after 3 years and the salary you would receive as a receptionist. The loss of experiences, education and fun you gain as a student is also an opportunity cost.

2. If you decide to go to university the opportunity cost is the 3 years salary you would have received as a receptionist at the hotel.

Often, investing decisions are considered in terms of opportunity cost.

Opportunity Cost and Investing

This is a common scenario for most people including myself. Imagine that you are considering an expensive holiday, say 10,000 dollars. However, there has recently been a sizeable market correction (lower prices) and you see opportunities in the market (like in 2022). What do you do?

Here are two possibilities:

1. you take your expensive holiday and spend 10,000 dollars.

2. you take a cheaper holiday (say 3,000 dollars) and invest the remaining 7,000 dollars.

And here are the opportunity costs:

1. In the first case, taking the expensive holiday, the opportunity cost is how much the 7,000 dollars would return over the lifetime of the investment. Assuming an average return of 8% per annum this could be over 70,000 dollars in 30 years (compounded).

2. In the second case, the opportunity cost is the difference in pleasure you receive from your expensive holiday and your cheaper holiday. This is subjective and hard to quantify. I should stress that I am talking about delaying your holiday in this case and not forgoing the holiday completely.

What would you do in this situation?

We can look at another example which I come across regularly - the opportunity cost when learning a language.

Learning a Language and Opportunity Cost

Most of my students are excellent but there are always a few that frequently find excuses not to come to lessons. The two options are simple:

1. Attend the lessons regularly

2. Do not attend the lesson regularly

Just like in the previous example, some opportunity costs are hard to quantify and may not be obvious until decades later. Here are the opportunity costs:

1. the opportunity cost of attending the lesson is whatever pleasure you would have got by doing something else

2. the opportunity cost of not attending the lessons regularly is poorer performance. A feeling of always trying to catch up with other students often results in students giving up. The true opportunity cost is the effect that lower English ability has on the student’s future career. This may not become obvious until the executive level decades later.

I see the difference between students who study and students who do not study regularly reflected in poorer Cambridge English exam results.

Conclusion

We have seen how opportunity cost is very difficult to avoid unless we have unlimited money or unlimited time. How I deal with it is to be intentional with both my money and time. That means that I think very carefully about the long-term implications of the decisions that I take.

With regard to investing, I am quite happy to delay big purchases if there are opportunities in the market. As an example, I did not have an expensive holiday in 2022 or 2023 but I am taking my family to New York in August 2024.

Are you facing a choice between two or more options? What are the opportunity costs? How will you deal with the situation?

Words of the Day - Give up (something)

Give up (something) - phrasal verb - to stop doing or learning something before you have finished it, usually because it is too difficult.

Do you have any Business English questions?

Please email me and I will do my best to answer them in future newsletters.

Until Wednesday - have a great day!

Iain.

www.communicateenglish.com

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