I want to introduce the idea of Opportunity Cost and Sunk Cost to our everyday life and the fact that these two terms play a significant role in how to live our lives. A lot of the times, the terminology and the concepts we learn in the business world are very closely related to what we go through in our everyday life. The business world can be a very cruel and complicated place to survive in so a lot of the times, I like to break the concepts down into my own simple ways.
Opportunity cost and sunk cost
Basically an Opportunity cost is measured by the next best alternative in choosing between two or more things and a sunk cost is cost that’s spent and cannot retrieve back or recovered. The opportunity cost of a college student going to college is simply the sacrifice of working in the real world and making money. During the 4 years of college, the student opportunity cost is the sum of salary money in 4 years making in the real world. The Sunk cost of a college student going to college is the money spent on tuition, books, etc because that money is spent and will not be retrieved. There’s no absolute guarantee that going to college will result in a high paying job or even one in the first place. It’s assumed that the actual return meaning the money you put in for college will expect to have an outcome of a much higher salary when you graduate.
Actually there’s a very special connection between the idea of risk, decision making, opportunity cost and sunk cost because risk contributes to decision making and opportunity cost and sunk cost contributes to risk measurements. Costs are the factors that measures risk because the higher the cost of something, the higher the risk it imposes. Our decisions are based on our gains/losses (risk), searching for alternatives (opportunity costs) and spent expenses (sunk costs).
Making a simple decision like planning a dinner requires all of the factors discussed above. Human beings are decision makers and we are good at determining what’s right for ourselves and distinguishing between what hurts and benefits us. Deciding whether to cook a home cooked meal with fresh ingredients or ordering take out from a restaurant is a simple decision but requires a series of concepts. The opportunity cost of cooking at home is sacrificing the time to enjoy the ambiance of a nice restaurant and having food presented in your face without work. And the opportunity cost of eating out is practicing your cooking skills at home and having to take the time to get dressed up. The sunk costs would be not a guarantee that home cook food is delicious and the ingredients at the restaurant may not be fresh. The risks are your health going out to eat and spending money you shouldn’t be.
The importance of incorporating costs such as opportunity costs and sunk costs is to allow your decisions to be made wisely. Don’t make decisions you will regret later. It’s important to think about costs and risks because they will benefit in your decision making.