Opportunity Cost Analysis

Opportunity Cost Analysis

We dreamed of a long honeymoon in Australia. We requested leave of absences from work. We were excited. We wanted to go. But then, we did an opportunity cost analysis. And we completely changed our minds.


 

Opportunity Cost

In economic terms, opportunity cost basically means you can’t rule out the costs and benefits of alternate choices; you must calculate those into your decision making process. Here is a simple example:

If you choose not to go into work tomorrow, you must take into account the money you would have earned if you did go into work. You wouldn’t simply have a day off, your opportunity cost would be a day off and minus $X dollars for the money you missed out on making.

The True Cost

When we sat down to discuss the finances of Australia, we came up with two different totals. Our first total was purely based on travel expenses. That rough total came to around $8000 for both of us. Then we calculated opportunity cost…

There were 3 areas where we factored in opportunity cost: Income because we would be losing out on earning money through the leave of absence; Rent because we would have to pay rent regardless while we were away; and Bills because there would be bills such as electricity and internet that would still be deducted regardless while we were away.

1) Income – $2500

2) Rent – $1175

3) Bills – $70

Total – $3745

Therefore, we had to factor in $3745 into our initial travel estimate of $8000. So the true cost of the vacation ballooned from an already disheartening $8000 to a terribly depressingย $11,745.

Knowing When to Say No

$11,745 was a stomach churning amount. While monetary factors played a big role, there were other reasons that affected our decision making process.

First, we noticed our excitement for Australia faded as it got closer and closer to the departure date. It’s not that we don’t like traveling. It’s quite the opposite. But we had already gone on a few smaller trips throughout the year and we didn’t have the hunger to tackle a big adventure.

Second, we realized we didn’t have completely thought out reasons for going to Australia. Yes we would love to go see Australia one day, but we couldn’t come up with concrete reasons why we wanted to go. The more we dwelled on this, the more we realized it just wasn’t time to go. Yet.

Those reasons, along with the immense cost, factored into our decision to postpone Australia for another time in the future.

Do you factor in opportunity cost to aspects of your life? Is it a valid concept to apply to real life?

  • Yeah, it’s a valid concept to apply in real life. But opportunity cost is not limited to monetary or financial cost. In your case, by postponing your trip, you have forgone the pleasure and the experience of being in Australia. That’s the opportunity cost of postponing your trip. ๐Ÿ™‚

    • I actually never thought of it that way!

      Thanks for another perspective at viewing opportunity cost ๐Ÿ™‚

      • No problemo. Most people associate opportunity cost with monetary or financial value perhaps because the word ‘cost’ is kind of misleading. In economics, opportunity cost can refer to the financial value or the utility level (level of satisfaction after consuming one good/availing a service).

        • I guess it’s just easier to measure in concrete terms monetary factors over emotional ones (such as satisfaction) that leads to the monetary side being the focus of opportunity cost in many cases??

          • Yes, that’s true. And utility level is subjective.

  • I don’t do this often enough, but can appreciate how detrimental it can be. With that being said, I guess I just have to wonder if there will ever be a time where you can do the trip at a lesser cost. Will it be worth going one day?

    • Thanks for the comment Cait!

      Well I guess a big part of decision wasn’t purely financial: we just didn’t really feel like this year was the right year for it. Don’t get me wrong, we love to travel and adventure but we couldn’t come up with many “we HAVE to go for [this]” reasons.

      Going in a future time could also be beneficial for a few reasons: more vacation time; less or no student loan debt; and a better idea on what we want to go see/do and why.

      So in our circumstance, I think the decision to defer an Australian trip into the future was the correct one! ๐Ÿ™‚

  • Loved the blog post and also the comments from the first two responders. All thought-provoking. Another factor would be what else would you do with the $ 8,000? Invest? Smaller trips? Pay off debt? Those have different types of pay-offs as well.
    When we are looking at a travel purchase, we have gone both ways… going to Europe, while possible, seems not worth it with an 8 year old who gets wacky from lack of sleep. Re-evaluate in 2 years. Other trips have been a “go” – daughter loves US history and presidents, so a trip to DC was a “yes” because it was the right time for her to enjoy it when my husband had a work training event there.

    • Very cool that you guys have been able to find a way to vacation so well with your kidlets!

      Just like your example with the Europe trip, I think sometimes it’s good to really assess what’s best for us in the current situation rather than just going with something because we had planned for it. Plans can change and being flexible with ones plans is a good thing.

      And in terms of the money “saved”, well we are just going to take a shorter trip around locally in our province and go on a couple smaller weekend trips!

  • Would you post the breakdown of how you found the $8000 cost estimate for your Australia trip? Let the blogosphere help you discover options ๐Ÿ™‚ There may be ways to lower expenses. This is what I am doing for Norway, which could be a very expensive trip if I only took conventional travel options. I hope you guys get to go someday!

    • Haha ya it was very rough estimates based on conventional pricing. The flights alone on the path we wanted to do (Van-HK-Aus) was $2500 per ticket. Then we just thought around $3000 in all other expenses was a rough estimate.

      We definitely will go one day! Just not this year ๐Ÿ™‚

  • And yes, I factor opportunity cost into everything I do. Maybe too often… :/

  • But most people ‘ain’t nobody got time’ for cost analysis. Period! And so a lot of us complain why at the end of the year, our savings and investments are suffering.

  • Loved your article. The concept of opportunity cost can be difficult to grasp. I also use it in business working with clients when they have to make major decisions, it can really help clarify their thought processes.

    • Thanks for the comment mymoneyseekerblog! I think it’s great you introduce the concept to your clients: it definitely is an important factor to consider when making big financial decisions!