Information about opportunity cost

Basic information about opportunity cost

Have you ever thought about the cost of going out with your friends? Or have you thought about the cost of your university studies? Or the cost of starting your own business? You may omit the opportunity cost from your calculations and estimate it as a monetary cost, but this cost is not economically accurate, as there are implicit, imperceptible costs involved in each of the previous options.

The concept of opportunity cost‌.

Limited resources require us to always be in the process of choosing one opportunity from among many. We will always have several options, but we can only choose one option to do, because we live with limited time and money and we cannot be in two places at the same time. .

For every opportunity we choose, we pay two costs. The first is the money or time we pay, and the second is the benefit of the opportunity we gave up. The cost of traveling for the purpose of tourism twice a year is what we missed in investment returns if we invested it, and the cost of going out with friends is sacrificing rest time. The cost of spending time with family is offset by missing out on wages for working extra hours.

There is something to gain and something to lose with every choice you make!

After understanding the concept of opportunity cost, we can define it as the returns or benefits that we lost from the best option left behind. If we imagine that we arrange the benefits of the options available to us from the greatest benefit to the least benefit, then the opportunity cost is the benefits achieved from the second option. If you have ten riyals, you will prefer to buy coffee with it, and if you do not have it, you will buy sweets. Buying sweets represents the second option, which is the opportunity cost of buying coffee.

The importance of understanding opportunity cost.

You may think, dear reader, that the concept of opportunity cost is a purely economic concept, but this concept is applied in all aspects of life, and understanding it correctly helps us improve the quality of the decisions we make, and thus improve the quality of life as a whole.

When we are informed about the potential costs and benefits of each option, it helps us choose the best available opportunities and prepare for possible consequences.

When you start switching between Twitter, YouTube, and Snapchat, ask yourself, is this the best option available for your free time? Before starting graduate studies, ask yourself: Does this option provide the best returns for money and effort? Before resigning from work to start your own project, ask yourself: Will it achieve returns greater than the job?

Every decision you make represents a trade-off with other options. This requires taking the time to research and think. We must emphasize that estimating the opportunity cost is a relative matter that varies from person to person and from time to time, and there is no accurate mathematical method for estimating it. It also entails psychological benefits that cannot be quantified monetarily, such as security and stability.

The present is the reflection of your decisions in the past, and the future is the improvement of the decisions of the present!

Opportunity cost and the future value of money.

Most decision-making tends to favor immediate consumption, but our awareness of the opportunities we will forego motivates us to compare the prices, returns, and benefits available between multiple options, both in the short and long term.

The cost of studying for a master's degree is not estimated only in the monetary costs paid to the university. You will often prioritize your time to study, so you will miss out on wages for the hours that you could have worked instead of studying, in addition to missing out on practical experience, which will be a key factor in determining your wages in the future.

To know the opportunity cost of studying for a master’s degree, imagine with me two scenarios:

• The first scenario is that you worked hard at your work, developed some skills and took some courses.
• The second scenario is that you completed your master’s degree full or part-time.

After three years, compare your wages in the first and second scenarios. If your wages after the master’s degree are higher than working, the study option will actually be the best option.

Another simpler example, imagine with me that you have an empty commercial property. You will have two options: either to rent it for 40 thousand riyals annually, or to start a commercial activity in it. Here you will think that you do not have the cost of the property because you are the owner of the property, but in calculating the opportunity cost they see You have the cost of a property, which is what you can get if you rent the property. If the income achieved from starting a business within the property is less than 40 thousand riyals annually in the worst cases, starting a business will not be the best option.

This comparison also applies to buying a lifetime home, or buying a home that is appropriate for the stage, or even renting it. Are the benefits achieved from purchasing a lifetime home greater and worth freezing the price of the property? Or will real estate investment generate higher returns in the long term?

`“The true cost of any purchase is not the actual cost in dollars. Rather, it is the value of the investment you did not make, because you used your money to buy something else.”

Warren Buffett.

One-time opportunity cost

Assuming that you received a windfall income of 10,000 riyals, you may intend to take a trip with the family with this amount because it is a windfall income and you did not incur any costs to obtain it. But if you invest it in a diversified, balanced portfolio with a profit rate of (10%) annually, after ten years it will be approximately (26,000) riyals, and if you wait an additional five years, it will reach (41,780) riyals, with the profits added to the principal amount. In this case, the opportunity cost of traveling with the family is the return on investment that you did not earn.

The opportunity cost of small, regular savings over time

You may think that buying a cup of coffee for ten riyals depends on whether you want the coffee or not, but the opportunity cost makes us wonder: Is it worth this value? What would I give up now for a cup of coffee? What would I give up in the future to get now?

The opportunity cost of buying a cup of coffee for ten riyals three times a week is equal to 120 riyals per month, per month for a year is equal to 1,440 riyals, and the cost of daily coffee for 10 years is 14,400 riyals, in addition to the returns that could have been achieved if this money was invested.

If the cost of coffee was invested three times a week for a year with a total of 1,440 Saudi riyals on a regular basis in an investment portfolio, the amount would grow to 3,735 riyals within 10 years, reaching 6,015 riyals after fifteen years.

Do not underestimate the alternative opportunity for simple daily expenses, because as they accumulate over time, they will have a significant impact that exceeds your expectations.

In conclusion, dear reader, remember that every decision you make includes an invisible cost, which taking it into consideration can affect improving the quality of your life and investment decisions.