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Your Opportunity Cost

University business professors and people in general love to talk about opportunity cost. The semi-rhetorical question, “Should Bill Gates mow his own lawn?” is the tried and true lead-in to a lengthy discussion of how much he makes per year, then per day, and finally per hour. Inevitably the professor and students conclude that if Bill were to mow his lawn, it would be the most foolish mistake imaginable to the human race.

There are two real questions here (and a third raised for us personally by the discussion):

    1. Are we talking exclusively about what results in a person’s earning/saving/netting the maximum amount of money?
    2. Should we take into account “softer” opportunity costs such as quality of life (e.g., time spent with family, on hobbies, etc.)?
    3. How do I decide whether to do something myself or to pay someone else to do it?

Maximizing Net Increase

If we are talking about the situation in which a person earns or saves the maximum amount of money, then in certain cases — even for high wage earners — it might make sense for Bill Gates to mow his own lawn. What if Bill’s schedule includes some discretionary time during which he didn’t intend to earn any money? He could mow the lawn and save the money he would have spent having someone else do it, thereby “netting” the maximum amount of money given the circumstances.

However, if he were paid by the hour and he took time when he could/should have been working, there’s a very measurable and direct opportunity cost. There would also be a strong financial disincentive associated with his mowing the lawn.

The “Softer” Costs

What does Bill give up in order to mow his lawn? If it’s monetary in nature it’s usually referred to as “opportunity cost”, and if it’s a “softer” cost it might be more accurately referred to as “sacrifice”. If by mowing the lawn Bill misses an opportunity to attend his son’s little league game, or to enjoy dinner with his wife, or to take a vacation with family and friends, that’s a very real (though difficult to quantify) cost. He would be sacrificing something relatively more enjoyable for something less enjoyable.

These circumstances require less logic and more personal judgment because each of us has our own set of values and priorities. That’s why decision making — when based exclusively on monetary opportunity costs — is not usually the best approach

“Build vs. Buy”, Sort Of

For the rest of us who don’t earn money at a monstrous hourly clip, our opportunity cost is much lower than it is for Bill. Let’s consider the following set of conditions:

    • your car needs some work that you’re capable of doing
    • you have several hours one evening when the rest of your family (and friends) are asleep or otherwise occupied and won’t miss your company, nor will you miss theirs
    • your job doesn’t compensate you for work done away from the office or after hours
    • you have no side businesses where you earn a dependable hourly rate for your efforts
    • you hadn’t intended to exercise, study, or relax
    • in short, there would have been several hours that evening that would have completely gone to waste

Given the above situation, why would you not take advantage of the chance to save yourself some money? Since repairing the car has essentially no opportunity cost, there’s no reason not to do it. Change any of the conditions described above and the decision becomes (at least a little) more difficult.

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Let’s consider the following scenario:

    • your lawn needs to be mowed and from past experience you know it will take you one hour
    • you’d much rather spend time with your family, but you also like to be careful with your money
    • you know a kid who mows lawns and he charges $15 for yours
    • your company pays you “time” for hours worked beyond 40 in a normal work week and you make $30/hour

Given those details, it probably makes much more sense to work (for your employer) for a half hour than to mow the lawn. Ignoring income tax, you’ll earn enough to pay the lawn-mowing kid and have an extra 30 minutes to spend with your family. You break even financially and net free time.

Other Considerations

Beyond strict monetary opportunity cost, there’s also personal preference. We have things that we enjoy and things we’d rather not do. That will color our decision-making process. The lower the financial opportunity cost, and the greater the emotional opportunity cost (i.e., the difference between how much we prefer doing one thing instead of another), the more likely we are to go with what we really want to do.

Safety shouldn’t be completely ignored either. If you need to do something that has a high risk and/or high likelihood of failure, it probably makes sense to pay someone to do it.

Conclusion

Because there are so many details that can factor into a decision, opportunity cost alone won’t determine the most appropriate course of action for us. Usually we don’t literally trade one money-making hour for another of equal or lesser value. Instead we are forced to weigh the pro’s and con’s and for most of us that means we’re better off (at least financially) doing the work ourselves, unless it’s something we really hate.

Check out these posts for other bloggers’ opinions and some lively comments!

4 comments to Your Opportunity Cost

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