Thursday, July 5

Interview with a Diva and Opportunity Cost

Well, I'm feeling popular today! Check out the interview that Canadian Dream did with me at his blog. It turned out pretty nicely, I'd say. Thanks CD!

I want to talk a bit today about opportunity cost. Now, I have to admit that I slept through my first year economics and then steered clear of the subject for the rest of my degree, but my understanding of this concept is basically that when you choose to do one and you aren't able to do another thing then there is a cost to the lost opportunity. (If I got it wrong, feel free to correct me, but I'm running with it!)

Now this is a really interesting concept because it points out to me that there are several things to do with my money, but once I put it in one place, I lose out on the benefit of any other alternative. We all know this at some level, but how much do we really analyze what it means to us?

Here are a few examples. The opportunity cost of:

  • leaving too much in your chequing account is interest that could be earned in a savings account
  • buying a new car this year instead of waiting one more year is one year's worth of payments (less repair costs to keep the old car running) that could have been saved and invested
  • buying a GIC is not participating in the higher expected long-term growth of the stock market

I'm sure you can think of more, and better ones!

This relates back to my housing musings earlier this week. You see, if I can rent out the space I'm living in for $1200 and move into a place that would be just as good for me at a cost of $800, then staying has an opportunity cost of $400 per month. The numbers may be fictional, but I believe that the concept is valid. I need to figure out what the best use of my available resources is, including the space that I own (my house), so that I am not wasting without even realizing it.


Promod said...

I'm attending my first university class: economics. A guy in jeans and a red plaid shirt stands at the front of the class and starts talking. Who's this buffoon? The professor --- dressed like a student ?!?

Opportunity cost (as I recall it) isn't just money. It can also be time. For example, moving further away from work may save money on accommodation (even after factoring higher transportation costs). But there's more time spent travelling, which means less time for other activities. In a place like Toronto, you can easily spend 2 hours per day travelling. If there's an emergency and you've got to get home, too bad.

There's also the question of utility. Say you buy a car or camera or computer now instead of waiting another year. You're able to use it for the year. That utility also has a value, but is harder to quantify.

GIV said...

I sort of equate it to sticking with a lousy mutual fund.

You keep the turkey in your portfolio becaus ethat lets you deny it's holding you back. You can say "I've borken even" or worse, "I'll stick with it till I'm back to even"

Meanwhile, that cash is tied up where it can't be put to better use in an investment taht can meet your goals.