The acceleration of everyday life, together with the continuously increasing range of consumption options, means that individuals (have to) make more and more decisions more and more quickly. Many of these decisions are intuitive and appear rather irrational when viewed from the outside. If individuals do not choose the best possible alternative, this means that the available resources are not (or cannot) be used optimally. It should therefore be in everyone’s interest to improve their own decision-making process. An essential aspect of this process is the consideration of opportunity costs, which are often neglected in practice. Thus, the question arises whether individuals should place a stronger focus on opportunity costs in individual decision making. This post will consider what opportunity costs are, the extent to which they influence behavior and the decision-making process, and whether the benefits of taking them into account justify the additional effort involved.
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To understand why opportunity costs can be an important part of individual decision making, it is first worth looking at what is meant by the term opportunity cost. Investopedia defines it as
“the potential benefits an individual, investor, or business misses out on when choosing one alternative over another.”¹
In practice, many definitions can be found that differ only in wording but express the same idea: Individuals have to choose between different alternatives when using their limited resources and this selection leads to the fact that not all desirable outcomes can be achieved. Put simply, this means that individual resource use must not only create value, but that value must be higher than the value that would be created by the next best alternative. This principle can be applied to almost all resources, but in everyday life it essentially refers to the two central resources available to individuals: time and money. Since the consideration of opportunity costs carries significant implications for the choice of the best possible alternative action, it should be a central part of the decision-making process. However, Spiller (2011) emphasizes in his work that in reality this is not the rule but the exception. The goal of his work was therefore to investigate in which situations individuals take opportunity costs into account and how this affects the lives of the individuals in question. He concludes that people only include opportunity costs in their individual decision-making process when they are aware that the available resources are of limited use and/or when the respective individuals have a strong propensity to plan in the first place. Individuals who consider opportunity costs tend to be in a better financial position than those who do not. At the same time, the author emphasizes that continuously weighing all alternatives can have a negative impact on well-being, even though the corresponding individuals always choose the best possible alternative. The higher dissatisfaction, which at first seems contradictory in this context, probably results from the fact that the perceived value of each alternative is weakened when the best possible alternative is compared with the other available options.²
However, opportunity costs can occur not only when decisions are made, but also when they are not made or delayed. If delaying a decision results in weakening the outcome of the alternative action, then opportunity costs can create time pressure that can affect the achievement of goals. When such pressure is present, it often leads to a decrease in accuracy and decision-making strategies must be adjusted accordingly. To achieve set goals, the decision-making process should be broad rather than deep. Instead of fully weighing the individual options against each other, the entire spectrum of alternative courses of action should be taken into account and the decision made on the basis of relevant attributes. Although the time pressure of opportunity costs is common in practice, it is difficult to estimate it realistically, so users often face complex decision problems.³ Shaw (1992) also points out in his work that the consideration of the individual’s available time in particular is far more complex than is often assumed. He emphasizes that there is a difference between the value of time and the opportunity costs; otherwise, people’s time would be virtually worthless without a labor wage. The mathematical elaboration is beyond the scope of this blog at this point, but the underlying insight is still relevant in the context of this post. If individuals want to consider opportunity costs as part of their decision making, one’s time cannot be equated with one’s labor wages. Traditional models of economics would need to be adjusted accordingly to account for the complex relationship between the value of time and the opportunity costs of time.⁴
Perhaps the strongest argument for considering opportunity costs is that decisions that disregard them are often irrational. Our everyday actions are usually based on a trade-off, which can be represented by the opportunity cost: A decision in favor of something is equally a decision against something else. Individuals who weigh the different alternatives are predisposed to make better decisions. Although an exact quantification of opportunity costs would often be costly, even a rough estimate can make the decision-making process more effective and efficient. As described above, constantly comparing the different alternatives can create a short-term dissatisfaction that many might see as something negative. In particular, individuals who have long-term goals and are aware that this dissatisfaction may be a necessary evil to achieve ambitious goals and succeed should not be deterred by it. Even if, contrary to expectations, the achievement of goals is not positively influenced by this, it can still be assumed that the individuals concerned will at least appreciate their available, scarce resources more and use them more consciously. From this perspective, it would seem to make perfect sense to educate the population about the effect of opportunity costs in the decision-making process and to assign them more weight. Weighing up different alternatives on the basis of the costs accepted makes it possible to make rational decisions and act with foresight.
Even though human behavior is exceedingly complex, it can be assumed that individuals strive to improve their own situation and therefore try to make the best possible decisions. However, this assumption does not seem to be supported in reality. Time and again, individuals make irrational decisions and undermine their own success. One explanation for this is the lack of consideration of the opportunity costs associated with a decision. The fact that a decision for something is at the same time a decision against something else means that the different alternatives have to be weighed against each other. The fact that an action creates value for the acting person is not sufficient by itself to justify taking that action, when opportunity costs are taken into account. Instead, its value must be higher than the value the person assigns to the available alternatives. Only in this case can resource allocation be effective and efficient. Thus, it can be argued that it is beneficial in the long run to place greater emphasis on opportunity costs as part of the decision-making process.
¹ Fernando, Jason (Reviewed by Amy Drury, Fact checked by Pete Rathburn). 2021. “Opportunity Cost”. Investopedia. Accessed September 27, 2021.
² Spiller, S. A. (2011). Opportunity cost consideration. Journal of Consumer Research, 38(4), 595-610.
³ Payne, J. W., Bettman, J. R., & Luce, M. F. (1996). When time is money: Decision behavior under opportunity-cost time pressure. Organizational behavior and human decision processes, 66(2), 131-152.
⁴ Shaw, W. D. (1992). Searching for the Opportunity Cost of an Individual’s Time. Land Economics, 107-115.