I was recently discussing pay with some freelancers I know, and I have net present value on the brain thanks to class this semester, and it all morphed into one conceptual idea: your desired pay is a net present value problem.
Your willingness to supply labor is dependent on your opportunity cost: how much do you have to be paid in order to make it worth your while to come to work? The higher your opportunity cost, the more you need to be compensated for your time. If you are a panda at the luxurious Research Base of Giant Panda Breeding, all you have to do is stay alive and look cute for tourists, and how hard is that for a panda? Everything else is done for you; even a lot of the breeding is handled through artificial insemination. What’s your incentive to do anything else?
The thing is, the more you need the money, the more likely you are to take the work that is offered, even if it is not terribly appealing or lucrative. Your opportunity cost is lower If you need $6000 per month to support your lifestyle, then your opportunity cost is -$6000 – a lower cost than someone who needs only -$1000 per month. Yes?
In academic finance terms, opportunity cost is included in the cost of capital, r. The cash flow, which we can think of as the pay, would be the numerator in the present value equation. CF/(1+r). The higher the value of r, the lower the discounted value of the cash flow, and the less valuable to pay offered is to you.
In other words, one way to make more money is to increase your opportunity cost. You can do this by needing money less – as backward as that may seem – or by increasing your skills so that the demand part of the competitive market is higher. The more offers you have for your talents, the more you can charge.
I’m not sure this is the best explanation. It may be overthinking pay negotiations, or I may be missing something. What do you think?
