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Termites and Economics

by Derek Sisterhen on June 8, 2010

Ever wonder why your dining out budget has a tendency of blowing up in your face? Or how that nebulous “miscellaneous” category in your budget inflates to two or three times what you planned?

Before you get to supply and demand in an economics class, there are two concepts you must understand. First, you live in a world of scarcity. That means that you have a limited set of resources to work with. Sounds like your paycheck; you have a set amount of money available to use.

Second, you live in a world of opportunity cost. That means that if you spend any money on any item at all, it not only costs you the price of that item, but it also costs you the opportunity to use the money elsewhere. Thus, if I save $100, that’s $100 I can’t use to buy groceries. If I spend $300 on groceries, that’s $300 I can’t use to go on vacation. If I spend $500 on a vacation, that’s $500 I can’t use to get out of debt (or buy groceries or save).

So, in essence, every decision I make with money has a ripple effect across all of my spending categories.

I met with a couple recently who felt so compelled to spend money on their children – because they loved to see them happy – that they weren’t making their mortgage payment. I told them they were living with financial termites: to the kids everything appears just fine, but the insides are rotting to the core. There would come a day when the money for “happiness” would run out and they wouldn’t have a home.

In their case, the opportunity costs of happiness spending are keeping the roof over their heads, being able to fund emergency savings, contributing to retirement, taking a family vacation. The list goes on and on.

Ultimately, a budget is nothing more than a list of decisions we make that will have a positive impact on our financial situation. In the execution, though, we tend to forget that overspending anywhere in our budget means we must underspend elsewhere just to get back to even. The consequences of this brand of forgetfulness are quite negative.

Kind of like termites.

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