If you pay 12% to borrow & receive 6% interest on your own funds, do the opportunity costs of borrowing & using your own funds differ? Why?
Lenders perceive that you are risky, so you must pay 12 percent annual interest to borrow from one of them. You only receive 6 percent on funds you have deposited in the bank. Do the opportunity costs of borrowing and using your own funds differ in this example? Explain why or why not.
Yes, the opportunity costs of these two options differ.
Let's say, for the sake of having easy numbers, that you want to use $10,000 and you have the choice between borrowing it and using your own savings. If you borrow, you will incur interest of about $1200 in the first year. Thus, your opportunity cost for borrowing would be whatever you would have done with that $1200 had you not been required to pay it off in interest. If you use your own money instead of keeping it in the bank at 6%, you are giving up $600 of interest in that year. Your opportunity cost is whatever you would have done with that $600 if you had received it.
In this way, the opportunity cost of using your own money does exist, but it is only half the opportunity cost of borrowing.