Friday, 8 June 2012

Opportunity costs in everyday life: Decision making made simple

This blog has forced me to think about the amount of money that I have spent in a way that I have rarely done before.  I am now concentrating on getting the same products for much cheaper prices.  What this necessarily means is buying some things in bulk.  An example of this (as mentioned in my May 2012 expenditure review) was the ammunition I bought in bulk for my hobby of target shooting.  Discount buying is a common way of saving money and everyone does it - the number of bulk buying discount stores is testament to this fact. 

What I never really thought about though was the fact that in bulk buying we are making a conscious trade off between spending an extra amount now to lower the unit cost of the product that we want however this naturally means that we are outlaying more currently.  Again this would be no great revelation to everyone but the thing I came to realise is that we deal with this opportunity costs in almost every area of our lives and never really think about the fact that this is what we are doing.

In economics terms an 'opportunity cost' is the value of the next best alternative that we are giving up.  This does not need to purely relate to price.  For example the opportunity cost of me going on a date with a girl is a night out with the boys or a night watching some movies at home.  Obviously there is some financial cost to all of these outcomes but there is also a 'hidden cost' and that is utility or 'happiness'

There are some decisions which we can always come down with one particular answer.  There are others though were we may hum and haw for a while.  This blog has actually started to influence how I make some decisions. 
  • In the ammunition example above I knew that the more rounds I bought the cheaper I would get them not only because the price was getting cheaper but because it was a 1 hour round trip to the place where I buy my ammunition and there is an opportunity cost to my time
  • This blog complicated that decision somewhat because again as mentioned in my May 2012 expenditure review my expenditure for May was impacted by the fact that I had this cost in there.  Had I bought less ammunition my 'target' expenditure would have been closer to my goal however the unit cost would have been higher
Realising that you are dealing with opportunity costs can actually make conflicting outcomes (such as the one above) a little easier.  You can prioritise what the most important factor is to you (for me the more I thought about it the more I realised the point of this blog is about financial freedom so a lower cost is preferred) so I ended up buying a larger amount to save the money instead of the smaller amount which would have made the blog post look better.

You may point out that this is actually over thinking what is quite a simple decision but when I came to the realisation that I could apply this decision making process to almost any aspect of my life it was quite liberating.  Asking the question what is the next best option always helps makes decisions easier and I'm not sure that this is done enough.

I apologise if this post ended up somewhat 'preachy' and this was not my intention.  It just added another limb to my decision making process (and was one of the few limbs that made a decision easier) so I was keen to share it.  Anyway let me know what you think.  If you think I'm completely off the mark I would be keen to hear about that too!

2 comments:

  1. Completely agree with this post. It makes sense, at the same time though can become a consuming habit as well (I do this quite a lot myself), even with non financial decisions.

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    1. I completely agree with the time consuming part!

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