Stop using Opportunity Cost

Facebook today showed me a two year old article from Dollars & Sense on the costs of running a hawker stall in Singapore. I'm not sure why I'm being shown an ancient article but it could be on the back of the recent saga of hawkers being bullied by private social enterprise hawker centres. You can read about the saga here, here and here. What intrigued me in the article mentioned above is not so much the real costs of being a hawker, but the application of opportunity cost. The article said:

Initial Cost Of Setting Up Roast Paradise

For the initial metalwork and equipment needed to set up Roast Paradise at Old Airport Road, the owners spent about $10,000. This excludes the 2-month rental deposit required.

Aside from that, we must remember that both Randall and Kai incurred an opportunity cost when they spent 6 months on their apprenticeship program in KL. Even if we assume a low opportunity cost of $2,000 per month (remember, they could have been working during that time), this still adds up to $24,000 for both of them.

When we sum up the initial investment and opportunity cost, we are looking at about $40,000.

The writer added in an opportunity cost of supposedly $24,000 into the initial investment costs of starting up a hawker stall. Investopedia defined opportunity cost as the benefits an individual, investor or business misses out on when choosing one alternative over another.

Opportunity cost = return of most lucrative option not chosen - return of chosen option

In the first place, the writer has gotten the concept of opportunity cost calculation very wrong. From an economic viewpoint, the writer only chose to include the economic losses in the first 6 months and exclude the economic returns thereafter. If the two partners had not chosen the hawker path, they would still be earning the assumed $2,000 monthly salary, and not the $4,500 income they are enjoying now as successful hawkers.

Of course, this blog entry is not going to be a boring economics lesson. I just find it absurd that people could be so wrongly fixated on opportunity costs. Anyone who took Economics 101 would learn about the concept of opportunity cost. A mother who chose to gave up her job to become a SAHM (stay-at-home-mum) could incur a huge opportunity cost of her lost annual income x number of years out of the workforce. A house owner who chose to pay off his mortgage early and forfeits the chance to invest the money instead at a higher rate would incur an opportunity cost of earning the spread (investment return - mortgage interest rate). Two guys who flew to KL for a 6-month unpaid apprenticeship incurred opportunity costs of their lost wages.

Why is it that when people talk about opportunity cost, they are mainly interested in the monetary aspect as in how much money is being passed up. The article above did not mention how privileged the two partners are, to be mentored by the KL hawker and to learn all the ropes of cooking and running a roast meat and char siew shop, without paying a single cent of tuition. It is only fixated on the potential loss of income during the 6 months of apprenticeship. And I find that most people think this way as well. How so? It is perfectly okay to weigh decisions using the concept of opportunity cost; after all we can't do everything and we have to plan the most optimal usage of our resources. However, most people think of opportunity costs in only monetary terms, and not other aspects like personal or social costs. Some life decisions are too important to measure in just dollars and cents. What is the impact to the child whose mother chose to gave up her job and become a SAHM? What is the worth of the peace of mind of having no mortgage on your property?

My wife quit her job two years before the birth of our first child. Even though she was earning over $200,000 annually in an European bank, the job was getting stressful and, frankly, possibly affecting our chances at fertility. It wasn't an easy decision to give up an annual cash flow of over $200,000, but it turned out to be one of the best decisions we could have made. She got pregnant the following year after she quit. If she had not resigned back then, we probably wouldn't be blessed with two lovely kids now. We would have more money now, sure, but so what?

Of course, it's easy to use my personal example on hindsight, but as I admitted it wasn't an easy decision back then. We took the plunge and were fortunately rewarded, non-monetary wise. The point is, for major life decisions, do not use opportunity costs to weigh the scenarios, for more often than not, you will place a higher emphasis on economic or monetary value. Instead, use the regret minimization framework to weigh your decisions, for when it comes to regrets, you tend to think more on non-monetary aspects as after all, money’s only something you need in case you don’t die tomorrow.