Wednesday, August 4, 2021

Opportunity Cost Definition, Examples, and Antonym

Opportunity cost is a fallacy that is often treated like a law. In addition, the opposite of opportunity cost provides more value than the idea of opportunity cost. To start, let’s examine the definition of opportunity cost and an example.

Opportunity cost is described as losing a potential gain because you chose an alternative. For example, if you invested in bonds and make 1% back you may not be happy (Ex. getting $1 yield for that $100 bond investment) . You might be disappointed because you look at your stocks and you got 9% ($9 for that $100 stock investment). That lost $8 from deciding to invest in bonds, instead of stocks, is opportunity cost. However, opportunity cost can be described outside fiscal frameworks as well. A student who spends time studying history may have some opportunity cost, when compared to their engineering classmate. They both had the same amount of time, but the engineering student may received a job offer for more money than the history major. The way most people boil down opportunity cost is to simply call it “bad decisions that cost”.

So, why do I call this a fallacy or lie? There is the obvious that you simply don’t know what might have been, because it never happened. The history student above might have transferred to engineering, hated it, and dropped out. It might have been a maximization of their efforts to study history. The same is true for the bonds example above. The stock might have been a loser compared to the guarantee of the bond yield. You never truly know the accurate opportunity cost of decisions. However, there is a second fallacy I would like to point out.

There is an analogy I watched on YouTube (video below) that describes how workers gain wealth through automation. However, it is not a straight line to success. Instead, each automation of a process produces less and less yield. The first automation of a process is ground breaking and provides massive changes. The 100th automation of a process might only produce a nearly unrecognizable gain. While not a law of nature, it’s great to keep the pareto principle in mind. That theory states that 80% of the outcomes come from 20% of the causes. You can think of those first automations as the initial 20%. They are put into place and now the process is 80% automated. To get the process to 90% automation, you may need to layer on innovation after innovation. It is a lot more work.

So why does this prove that opportunity cost is a fallacy? The answer is that opportunity cost is often thought of as a straight line. However, opportunity cost is on the same pareto principle curve. Using the same example above, it may not matter if you study history or engineering if your father has a business he wants you to run. While it’s true that engineering may help you fix stuff around that business, it’s not enough to be a large change in profits. The same is true for stocks and bonds. If you plan to sell either inside a year, before they’ve had time to produce compound interest, it doesn’t matter the investment vehicle. Opportunity cost isn’t a straight black and white ratio, but instead needs to be reflected on end outcomes.

So why does the opposite of opportunity cost provide more intellectual value than the idea of opportunity cost? To examine this, let’s see what the antonym would be. Some people describe this as opportunity benefit. In their model, your actions lead to more possibilities. For example, a wise investment leads to more capital, which means you can make more wise investments. I personally don’t like this concept because it assumes that more choice is good. I believe that analysis paralysis (having so many choices you can’t chose any of them) breaks this idea. Simply having more possibilities doesn’t show that they are relevant to outcomes. For example, a wise investment may be a fluke and lead to an ego where one thinks they can ALWAYS make wise decisions. That’s not accurate.

Another antonym for opportunity cost I’ve found is the ‘reverse victory’. The idea for this is that the more you are successful, the worse the overall outcome. For example, an investor scared of losing out diversifies to a lot of investment vehicles. By trying to go everywhere at once, they never travel far enough down any particular road. They gain an average return on their investment, instead of having a superstar investment that outperforms the average. I like this framing better because it has a much more solid grasp on outcome. However, this thinking still is too closely connected to the opportunity component. I don’t think the number of opportunities is as important as the impact of opportunities.

So what do I describe as the reverse of opportunity cost? I changed both words and produced the phrase ‘energy gratitude’. Let’s break this down a bit more. Instead of opportunity, we have energy. This reverses an intangible quality, opportunity, to a tangible one: energy. In addition, this reverses the end result (an opportunity) and instead focuses on the beginning of effort (energy). Next I break down the ‘cost’ part of ‘opportunity cost’. My reverse for this word is gratitude. When you look at cost you are examining the potential amount that needs to be given to make it work. The cost of a cup of coffee is the $5 you need to give to make that happen. The flip of this is to realize that nothing needs to be given out, but instead reflected inward. Instead of looking at what needs to be extracted, you look at what can be retained. This is where gratitude comes into play. Looking at what you have inside instead of looking to what you can extract out from yourself. Another way to break this down is: opportunity cost is like making a mistake then being specific on why you regret that decision. Energy gratitude is like knowing what you can accomplish and taking a moment to revel in that.

So, by this point, it should be somewhat obvious why focusing on energy gratitude is more important than opportunity cost. Beyond the psychological gains from positivity, there are also the end outcomes to consider. By focusing on opportunity cost, you are looking at the past. What did you lose out on? By focusing on energy gratitude you look at what your energy COULD do. It is focusing on the future and being happy about that. To me, that’s the real way you use the pareto principle in your life. Focusing on the big parts you can control and being grateful to have that ability.

As promised, here is the automation video I referenced above:


Long Tail Writing © 2019

Blogger Templates by Splashy Templates