I once asked an Economics Professor to contribute an article to Simple Money Magazine.
My instructions were vague on purpose, “Assume you had opportunity to teach just one economic principle to every person on the planet. What is the one lesson you think is most important for everybody to know?”
I didn’t know what he would choose to write about. But to be honest, I was pretty intrigued to see which principle he would choose.
Want to guess what economic lesson he decided to teach?
Don’t overspend your income? Save every month? Learn about compound interest? How to create a budget?
Nope, none of those.
The ASU Economics Professor wrote about the economic principle of “Opportunity Cost.”
If you don’t know, the technical definition of opportunity cost is “the forgone benefit that would have been derived from an option other than the one that was chosen.”
In other words, with every purchase we make, there are sacrifices we assume—alternatives that we must forgo. Every dollar spent on an item is one less dollar that could have been spent somewhere else.
I loved his decision to highlight “Opportunity Cost” as the one economic principle he most wanted everyone to know. It is a concept that is an important principle for life—especially in an age where consumerism and choice often cloud our judgment.
Of course, it is also a principle that carries weight beyond mere dollars. Because sometimes the purchases we make require us to forgo alternatives that are bigger than dollars and cents.
Take the example of choosing whether to buy a new car or not. On one hand, we can see the opportunity cost very plainly. If I choose to use my money to buy a new car that means I have less money left over for a vacation or new furniture or new clothes. But, if I have those things already, the opportunity cost seems slim.
Not to mention, there are advertisements, all day long on television, encouraging me to buy the new car. It will be adventurous, it will be flashy, it will draw attention, it will bring luxury into my life… it will spark new and amazing outings with my family that I apparently couldn’t take in my old car.
The decision quickly becomes an irresistible one. I want the new car and am willing to part with the dollars. The opportunity cost is worth it, I convince myself.
But what if the purchase of that car brings more than a new set of wheels into my driveway? After all, unless I am paying the full-price in cash, it will also bring a monthly car payment.
And debt, especially for a depreciating asset like a new car, becomes a constant burden. The immediate gratification of driving a new car off the lot is quickly overshadowed by the years and years of monthly payments, the interest, the insurance, the depreciation, and the stress of now needing to maintain something more valuable.
In this scenario, the “cost” of the vehicle wasn’t just the sticker price and terms of the car loan, it also cost me a measure of peace. The “opportunity cost” was more than just what items the dollars could have been spent on economically—the opportunity cost also included my well-being.
And, as the old saying goes, “Anything that costs you your peace is too expensive.“
In this scenario, I had to give up something potentially more valuable than dollars. I had to sacrifice calm, peace, financial freedom, and the satisfied feelings of knowing the car I drive is fully paid for.
Now, this isn’t to say that there is never a time when a vehicle needs to be replaced. It’s just to say: Given the options, it’s often better to drive an old car with peace of mind than a new car burdened by stress and debt.
And of course, the application of this principle extends far beyond the driveway. We see it all around us.
Almost every day, we are presented with opportunities to spend our money on more and newer things. And while not every purchase may require a loan like a new (or used) car, the cumulative effects of those financial decisions begin to play a significant role in our lives.
Consider these examples:
Smartphones. Every year, new models tempt us with slightly better cameras, marginally faster processors, or just a cool new color or design that everyone seems to want. Many people do choose to make a monthly payment on these devices. But even if you don’t, is buying a newer phone really worth the price every year—or even every couple years? Especially if there are other debts you are currently repaying? Wouldn’t it be better to use an older phone and get out of credit card debt than buy a new one?
Homes. The average American home has tripled in size in the last 50 years. They continue to get bigger and bigger. And we continue to buy them—despite homes becoming less and less affordable. But just because the bank pre-approves you for a mortgage loan doesn’t mean you need to spend the entire amount on your purchase. It is important to also ask, “What amount of my peace and life am I sacrificing just to live in a bigger house?” Wouldn’t it be better to live in a modest-sized home and experience more freedom than buy a big one?
Entertainment. A financial advisor once told me, “Most people who are struggling financially do so because they have overspent in one of three ways: 1) Too much house, 2) Too much car, or 3) Too much entertainment.” By entertainment, he meant the broadest definition (restaurants, vacations, alcohol, shows, sports, events). Restaurants and trips and shows are certainly enjoyable—and there is no shortage of them available to us. But if the opportunity cost is getting ahead financially, is it worth the expense? Wouldn’t it be better to find simpler forms of entertainment and no longer stress about money than spending money every weekend on entertainment?
We live in a society that confuses success with material wealth. In that world, fancy cars, big houses, and the latest gadgets are always worth the price. After all, that is where the good life is being lived.
But deep-down, we know better than that and want something different. We want to live responsible lives. Not in debt, but within our means.
To accomplish that, we must actively and intentionally wage war against the temptations to accumulate that surround us every day.
And one way we do that is to count the opportunity cost of every purchase. Not just in terms of the dollars that could be spent elsewhere (although that is a concern). But also in the peace and freedom we sacrifice in every purchase.
I don’t know about you. But I’d much rather live in peace with less, than stressed-out with much.