Aug 5, 2020

Opportunity Cost or How a Broken Fridge Can Turn into an Expensive Kitchen Makeover

Have you ever thought about about the difference between an expensive item and a lower-priced counterpart? The difference is not just the amount of money, but also what you can do with this money sitting between, say, a $1,000 leather jacket and a $400 one.

The $600 difference between the two jackets is the monthly payment on your car lease, the monthly insurance on your car, and a lunch out with your kids. No bad, right?

With this question, we've arrived to the interesting term “opportunity costs”. Understanding opportunity costs is an important aspect in how we can save more money. This knowledge will help you make better purchasing decisions.

When you spend $1,500 on a luxury item, instead of purchasing a similar non-brand item for $200, you are actually saying goodbye to $1,200 and everything that you could have with that money. It could be your monthly mortgage installment, loads of grocery, a number of lunches out with family and friends, and even a small amount to stash away for that dream vacation you’ve had on your mind for a while.

This above is a perfect example of opportunity cost or the value of the best alternative foregone. In simple words, the whole concept of opportunity cost means the maximization of your hard-earned money.

Opportunity cost is present everywhere in our lives. Say, you don’t want to drive to work in this 7-year old Corolla, but rather get a luxury brand. You can afford it! But look at it another way: what could you do with the money you save each month by keeping your old car instead of leasing or financing an expensive car? Attach a specific goal to this saved money - say, you will put this difference ($300) in your kids’ education fund!

Another vivid example of opportunity cost comes with the understand that some types of spending lead to more spending. Let me explain.

Your old fridge needs repairs. It would cost you $500 to repair it. But you could also buy a $1,500 brand-new fridge in no time. Seems like a no-brainer - you will go for a new fridge. Yes, it costs more that the repairs of the old fridge. But the delivery and installation are free. Let's ditch the old one and get a new one! Wait...

Then you notice the stove will look so bleak on the background of the new shiny fridge. And you are ready to go for the fridge+stove combo, which stands just at $2,500 with all combo discounts included.

Then it turns out there is not enough space to fit these new guys in your kitchen. You will have to do some work to open up some more room in the kitchen for the new shiny guys. That’s a $5,000 bill on top of what you’d be paying for the new appliances.

So, we are now facing 2 alternatives: $500 repairs or a $7,500 makeover. At this point, the savvy buyer will ask herself “What could I do with $7,000 if I didn’t buy the new fridge?”.

Another option would be to replace the fridge without the urge of upgrading the whole kitchen.

Opportunity cost may have a different face too. 

Look at your time. Say, you value your time at $50/hour, take it into account when you engage in different activities.

Changing tires on your car would cost between $70-90. Doing it yourself may take up to 4 hours if you don’t have much experience in changing tires. At this point, it’s worth bringing your car to a dealership or garage and not do it yourself.

Smart and savvy shoppers should definitely consider opportunity costs whenever there is a purchasing decision to be made. Make it your habit, and you’ll be able to spend your money in a more intelligent way.