Seth's Blog : Everything costs

Everything costs

But not all costs are the same.

There are three kinds of costs that people get confused about, but understanding them, really understanding them–in your bones–unlocks opportunity.

Opportunity cost: If you eat the cupcakes, you can’t also eat the brownies. Every time we choose to do something, we’re choosing not to do something else.

Sunk costs: If you’ve invested time or money in something (a law degree, a piece of real estate, a bag of chips) that money is gone. All you have left is what you bought, and that is a gift… a gift from your former self. You don’t have to accept the gift if it’s no longer useful to you. Using a gift still has real opportunity cost, and if it’s keeping you from doing something better, walk away.

Marginal cost: How much extra does this decision cost? For a subscriber, the marginal cost of watching one more show on Netflix is zero. The service costs the same regardless of how many shows you watch. On the other hand, the marginal cost of a tuna sandwich is equal to what it costs to replace the ingredients. It makes sense to prefer things with a lower marginal cost if everything else is similar.

I’ve never encountered a person who was fully rational in making decisions on any of these three sorts of costs. That’s okay. But let’s do it on purpose.