Economics Let You See the Hidden Cost of Your Daily Life

Economics has been defined in many ways. Some people believe Economics is all about money; some people believe Economics is all about wealth of nations; I believe Economics is all about making rational choices. Life is full of choices because our resources are limited (time, money, etc.). But our needs and desires are unlimited. So, how can we fulfill as much desires and needs as possible with limited resources? We have to prioritize the needs and wants, to allocate the resources and use them in the most efficient way.

Opportunity Cost

An opportunity cost is the cost of spending your time, money, and energy on one thing, instead of another thing. Every time when you make a choice, you are facing a direct cost and indirect cost. The direct cost represents the cost you choose to pay. For example, when you take money out of your wallet to pay for food, goods, and services; this is direct cost. An indirect cost example would be when you take money out to pay for foods, goods, and services; you automatically sacrificed the other possibilities to spend this money.  This indirect cost is referred as Opportunity Cost.

Opportunity cost triggers when you choose one option over another. It is an action of brainstorm the benefit and cost for each option, includes all direct and hidden cost, use your logic to determine which option will maximize your utility (the greatest value you can derive from making the decision). Although people try to make the best decision they can in every situation they encounter, it is very easy to disregard the opportunity cost.

Everyday there’s a lot of people think they just made a smart decision but actually not because they forgot to take opportunity cost into account. For example, I noticed many students try to save their notebook paper by write tiny word and try to fill out the entire page before flip to the next. However, the hidden cost of doing that is it hurts your eyes while reading and lowers the efficiency while organizing and studying, and the long-term cost is their vision will degrade faster than they usually would.

Another example would be one of my friend lives thirty minutes away from school (with traffic one hour), and he told me he wants to commute to school instead of rent an apartment nearby for save money purpose. All he considered was the gasoline cost for a month is cheaper than the rent cost but ignored the hidden cost that he will spend about two hours per day for driving plus the percentage risk of getting a car accident. These examples are just telling us that opportunity cost exists in every decision of our life.

As you can see, opportunity costs play a big role in personal finances. Every choice that you make in life has an opportunity cost attached to it, even if it is not easily seen. An opportunity cost doesn’t only include monetary costs, but it includes all real costs of making one choice over another, including the psychic profit of lost time, energy, and pleasure.

Sunk Cost

Like the opportunity cost, there is a “sunk cost” is another indirect or hidden cost. It is also exists in our daily life and affecting our decision-making. It is a “cost that has already been incurred and thus cannot be recovered.” A “rational actor,” as economists say, will completely ignore the sunk cost. When you take the sunk cost into account while making a decision, it is considered to be irrational. For instance, assume you purchased 100 shares of stock that worth $500, but after a month they falls to $50. The $450 you lost is a sunk cost and it is already irrelevant to you now. If you choose to hold that stock because you think you bought it for $500, you are making an irrational decision. From a completely rational perspective, you should abandon the original cost and only consider the prospect of the stock. If you believe the stock will keep falling, you should sell the stock to prevent future lost.

This also applies when you try to sell something you just bought or bought before. Many people said “I’m not going to sell it at this price, I paid ten times more than that.” No matter how much you spent originally, it is independent.When you are making the decision of sell or not sell, you should only compare the remaining value of the object with the price that buyer offers, not how much you paid for.After you start pay attention to the sunk cost, you will be able to make the best decision for each situation.

Since we are making choices all the time, the awareness of opportunity cost and sunk cost becomes significantly important in our daily life. Although it is very difficult to always consider these hidden costs into account, I would still encourage you to think about what else you could do with your money and time; think about these foregone opportunities when the next time you decide to spend those precious dollars, or spend your time doing something that does not maximize your life expectation. Last but not least, no matter how wealthy we get, resources are always limited, and therefore we should consider rationally in all the decision we make.