It is a common mistake of many an investor to think that they can only define opportunity cost by looking at the immediate results. As a fundamental principle of investing, this may work in theory; but in practice investors will often tend to trade based on the long-term result. In other words, what gets them the best result when all is said and done? Unfortunately, this also makes it very difficult to set and measure a standard of opportunity cost.
In micro-economic theory, opportunity cost refers to the loss or the gain which would have been gained if the alternative option was taken. For example, if a business owner were to spend two days and one hundred dollars on advertising and promotion, he/she might expect to see a five percent return on their investment. However, if they were to take this same five percent return but spend one day and one hundred dollars on advertising and promotion only, they would only see a one percent return. Either way, they have lost the two days and one hundred dollars – the amount necessary for the promotion. Now, in both cases, the amount lost is equivalent to the monetary value of the options multiplied by the number of times the investor has traded (multiplied by the number of days and dollars, respectively).
Unfortunately, it's easy to look at the results from such types of financial decisions and mistake them for an opportunity cost. After all, in these cases, there is no value in spending a thousand dollars on advertising and promotion if no one is buying your product. However, because we are dealing with micro economics here, this is how you define opportunity cost. You will know when you are spending too much – in monetary terms. The problem then becomes determining when you are spending too little.
There are several ways investors attempt to solve this problem. One way is to force the market to “reject” your advertising or promotion attempts; if you cannot get these products to the audience you want, you can always simply redefine opportunity cost by replacing it with a delayed or low cost alternative like discounts or pre-sales promotions. This solves the immediate problem, but the problem still exists: the audience is not informed as to the true value of your product until you tell them. And if you make the mistake of telling them too late, they will inevitably come back disappointed, taking their business elsewhere.
A better way to overcome this problem is to use the concept of suboptimal performance in your financial decision making. The idea here is that you can measure the results you want from a marketing or advertising campaign and assign a monetary value to that outcome. However, if you do not achieve the suboptimal results you were hoping for, then you should not continue the spending. This way, you are only investing money when you are generating returns, and since you are trying to beat the market, you can be assured that beating the market will not be suboptimal.
So, instead of using the opportunity cost example of beating the market, consider using the suboptimal situation as a teaching tool. Instead of trying to beat the market, consider trying to beat your own spending habits. This way, you know that beating your own spending habits is the optimal situation for you, and you are more likely to focus on what is most important to you: spending your money with the company that is most valuable to you. In this case, it may be worth it to beat the market, but if not, your company will most likely still be underperforming because you are not optimizing your spending habits.
Real-Life Examples of Opportunity Cost St | define opportunity cost
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