Read These Next
I was in heaven last week because my cable movie channel ran all five Dirty Harry movies in succession.
In Dirty Harry, during that famous bank robbery scene where Harry ends up spouting off his “Do ya feel lucky?” line, Inspector Harry Callahan gets shot in the leg. It is one of the most memorable movie scenes of all time, certainly as iconic as Sly Stallone climbing the steps of the Philadelphia Museum of Art in Rocky.
Not as famous, though, is the very next scene in Dirty Harry, where Harry goes to the hospital to get treatment for his leg wound. Still, it’s a great example of an individual evaluating an opportunity cost.
Doctor: Sure, Harry. We can save the leg. (The doc takes out a pair of scissors.)
Harry: What are you going to do with those?
Doctor: I’m going to cut your pants off.
Harry: No! I’ll take them off.
Doctor: But that’s gonna hurt.
Harry: Those pants are $151.76. Let it hurt.
I know. Harry actually said “$29.95.” But I adjusted the price to account for inflation.
In case you’re still unsure, opportunity cost is the measure of what you’re willing sacrifice to obtain a certain objective.
Harry evaluated the replacement cost of his pants against the pain he would endure in order to save them, and he determined that he was willing to put up with the pain if it meant he wouldn’t have to shell out another $151.76 to buy a new pair of pants.
In other words, for Harry, the opportunity cost was the pain he could have avoided by allowing his expensive pants to be cut off.
Financial opportunity costs
In a purely financial sense, let’s say Inspector Callahan wanted to buy a new .44 Magnum for $500. Harry’s opportunity cost of buying the gun includes everything he could have done with that $500 if he didn’t buy the gun in the first place. For example, he may have been able to invest that money and earn a rate of return of 6 percent over a 12-year period. In that case, his opportunity cost would be equivalent to $1,000 in his pocket 12 years from now.
Opportunity costs can take many factors into account
That hospital scene is a great reminder that comparisons may be made not only on a dollar-for-dollar basis, but also with respect to quality of life and/or personal preferences.
In our everyday life, it doesn’t usually make sense to make decisions based solely on a dollar-for-dollar cost comparison. In fact, emotional factors are a perfectly legitimate reason in making certain decisions when weighing alternatives. For example, many people who choose to pay off their mortgages early make a conscious decision to trade the potential for greater returns in exchange for the peace of mind of paying off the mortgage debt as quickly as possible and owning their own home free and clear.
Opportunity costs are unique for everybody
I have an awesome father-in-law named Tony who is an outstanding mechanic. He’s pretty much retired now, but he’s still a mechanic. As such, it should come as no surprise that he cringes whenever he hears that I’m paying mechanics to service my automobiles for what he says are relatively simple tasks like changing the brakes.
For Tony, the opportunity cost of doing the job himself is much different than it is for me. Not only does Tony know what he’s doing, he has the tools and the place to store them. He also doesn’t mind getting his hands dirty. And he’s retired, so he has the time.
In my case, however, it’s a much different story. After I factor in my time to make the repairs, my lack of tools, and a general dislike for grease and grime – not to mention the frustration I would be subjected to just trying to finish the task – the costs of paying a mechanic become easy for me to swallow.
The effect of personal preferences
It only makes sense that we’re more likely to choose what we enjoy doing as financial opportunity costs decrease and emotional opportunity costs increase.
For example, my wife and I made a conscious decision to become a one-income family after our son was born 14 years ago. Despite the fact that our net household income would have been greater if she had kept her job, we ultimately decided that the extra income was not enough to overcome our personal bias toward having our kids grow up in a house with a stay-at-home mom.
There are plenty of other examples that I’m sure you can come up with too.
When it comes to opportunity cost, the bottom line is this: Those who take the time to evaluate it will improve their financial well-being and increase the value of their time spent.
And if you don’t believe me, just ask Harry.