Opportunity Cost: Why the Twins Should Have Traded Joe Mauer.......

OK, so if you have been reading my sporadic blog posts, you know what a fan I am of Joe Mauer. Since the last time I professed my complete amazement at his remarkable abilities in a blog post, he has added another batting title and a Most Valuable Player award. Oh, I almost forgot, and his second Gold Glove.

You would have to be living under a rock not to have heard that our guy Joe was to be a free agent at the end of this coming season and was in line for a new contract from somebody. This contract decision was momentous for the small market, spendthrift Twins club. Monday, it was announced that our hometown hero signed an 8 year contract for $184 million. (Just a side note here: the entire “value” of NSFCU is about $110 million – hard to comprehend.)

So, here’s the logical conclusion that this baseball loving economist has come to: the Twins were crazy to sign Joe to this contract. The reason is the economic principle called opportunity cost. In a nutshell, opportunity cost can be defined as the total value of everything you could have if you didn’t make a given financial decision. In theory, this can be financial and non-financial. So, let’s assume the Twins said, “No thanks, Joe”, traded their slugger and withstood the wrath of their fans. The Twins would have likely received three to four young, starting caliber players in exchange for Mauer. Young is the key word here as players with less than 5 years experience “only” make $1-5 million per year. Let’s assume they received 4 players and each player earns an average of $3 million per year. This means they would spend $12 million per season instead of $23 million for Joe. Now, with the $11 million per year they still have left over, they could go out and sign one other top quality free agent to shore up any remaining weak spots, say third base or they could just save the money which, even with a meager rate of investment return, would be worth at least $120 million over the life of the contract. So the opportunity cost of signing Joe could be described as 4 excellent, young, starting ball players which would give them one of the best teams in baseball plus another top notch free agent or $120 million. Which scenario wins more ballgames?

Opportunity cost is very important for you to understand in your everyday finances. Consider the following scenario: you worked hard to pay off your credit union car loan in 5 years. Even though your car runs fine and could be driven for another 4 years, you are considering a new car for $30,000 because it is a good deal.

What’s the opportunity cost here? Let’s make a list:

Cost of the vehicle: $30,000
Tax and license: $2275
Interest on a 4 year car loan: $3070
Higher cost of insurance over 4 years: $2000
Increased license fees over 4 years: $800
Lost investment income on $30,000: $5000

Total: $43,145

(The lost investment income assumes that you save and immediately invest the monthly payment you would have made for the new vehicle.)

So, this purchase really doesn’t seem like such a good deal after all when you examine the true opportunity cost. Suddenly the new car smell just isn’t so important.

Opportunity cost is a handy idea that can be used for nearly any important decision, financial or otherwise. Hmmmm.......maybe the Twins should start reading this blog……..

Mark