I’ve found another great blog thanks to the author, Dong, commenting here at FreshBlogger. His blog can be found at AskDong.com and contains some valuable information about financial subjects. I just read his latest article on Opportunity Cost and Sunk Cost and found it to be well-written and easy for the layman to understand.
The article details the different costs that we should take into account when making financial decisions. In fact, as Dong points out, any decisions we make should take into account these factors, or not, as the case may be.
Basically, the article defines opportunity cost and sunk cost and what each means in the context of making decisions. Very briefly, opportunity cost is the cost of not being able to do one thing because you’ve chosen to do another. Sunk cost is the cost of whatever you’ve already spent, whether it was money, time, or effort. Read Dong’s article for a much more in-depth definition of both terms and some good examples.
I find it particularly interesting that we often consider what we’ve already spent when deciding to continue an activity. In a real economic sense, this doesn’t make sense. Dong mentions that it’s “throwing good money after bad” and this is true in a lot of cases. We tend to continue on in a bad job, bad relationship, bad investment, etc, just because of how much we’ve invested already.
Sometimes, this is the right thing to do when considering the opportunity cost. If there are no other jobs to be had, then the opportunity cost of quitting your job is clearly too high (unless you have another lucrative way of making money and/or trimming expenses). The opportunity cost of leaving a bad relationship may be that children will go without a parent or stable family environment. The opportunity cost of leaving a bad investment could be higher taxes in the short term or possibly some other penalties.
It’s not always a clear cut decision to make. However, the article offers some valuable insights into some important costs that we should consider in making decisions in our lives. If people spent a little more time thinking about the opportunity cost and less about the sunk cost, they might make better decisions. Check out Dong’s article and let him know what you think.