Opportunity Cost

by on September 2, 2005 at 7:15 am in Economics | Permalink

I was stunned to read Robert Frank's NYTimes column about a recent study testing economist's knowledge of economics.   Paul J. Ferraro and Laura O. Taylor of Georgia State University asked some 200 economists, many with PhDs from top-economics programs, at the 2005 annual meetings of the American Economic Association, a simple question:

You won a free ticket to see an Eric Clapton concert (which has no resale value). Bob Dylan is performing on the same night and is your next-best alternative activity. Tickets to see Dylan cost $40. On any given day, you would be willing to pay up to $50 to see Dylan. Assume there are no other costs of seeing either performer. Based on this information, what is the opportunity cost of seeing Eric Clapton? (a) $0, (b) $10, (c) $40, or (d) $50.

I have a hard time believing that this is possible but 78 percent of the economists gave the wrong answer!  This is not a hard question.  There is no trick.  Opportunity cost is central to economics, the people asked were among the best economists in the world, a large majority of them have taught intro econ and yet the correct answer was the least popular.

This is a professional embarrassment.

Test yourself against some of the world's best economists.  The answer is in the extension.  By the way, if you really want to learn economics come to GMU.  I guarantee that your professors understand opportunity cost.  We are also good on scarcity and incentives.  Comments are open.

The answer is b, $10.  Your next best alternative to the Clapton concert is attending the Dylan concert which has a benefit of $50 and a cost of $40 or a net benefit of $10.  The net benefit is what you give up by attending the Clapton concert.

The Eclectic Econoclast September 2, 2005 at 7:58 am

Let’s see, now. Do I net or don’t I?

I think this shows that opportunity costs are NOT and easy concept.
I often have grad students take my intro exams, and they do remarkably poorly
We really need to emphasize the concept a LOT more if we want people to understand the economic way of thinking.

Joe M. September 2, 2005 at 8:36 am

Huh?!!? I taught econ. at Harvard for 2 years as a grad student and I guarantee at least 70% of my first-year students would have gotten that question right after one semester (and the other 30% never paid attention in class).

I really find this hard to believe. Professional embarrassment is an understatement. I sure hope there was something seriously *wrong* with the way the study was conducted (I haven’t yet clicked through the link)…

Bob September 2, 2005 at 8:53 am

You would go to see Clapton if you were willing to pay anything to see him. Your net benefit to seeing Clapton is whatever you would have paid to see him, while your net benefit to seeing Dylan is $0 if the tickets cost $50

Slocum September 2, 2005 at 8:53 am

That was my answer, but it seemed so easy that I was really nervous about it. Can I have a PHD for that?

My reaction, too. $10 seems so obviously right that I can’t quite imagine what the logic would be behind arriving at any of the other answers. The only thing potentially tricky about the problem, I suppose, is that the free Eric Clapton ticket is a distractor and has nothing whatsoever to do with the answer. Would the the economists have gotten the aswer right if the question had been simply, “Tickets to a Bob Dylan concert are $40. On any given day, you’d be willing to spend $50 to see Dylan. What’s the opportunity cost of staying home to watch TV?”

Joe M. September 2, 2005 at 8:59 am

Tom – I think/hope you are correct about the wording of the question. Honestly when I first read the question I was a little confused about whether or not you already had tickets to the Dylan concert. I think it is clear if you read slowly; hopefully these “top economists” are just busy people who (rationally?) chose not to invest much of their scarce time carefully reading a meaningless survey question. Hopefully.

Turuk September 2, 2005 at 9:17 am

I had never heard about opportunity cost.. I went to read the first paragraphs of the definition on wikipedia… and then chose the correct answer! PhD for me too! ;-)

Peter K. September 2, 2005 at 9:45 am

Since the thesis of the post is that many, many economists — a whopping huge majority — do not know what “opportunity costs” are, and since this blog’s readers include people with less formal training in economics than a typical economist, would this post not be more readable to a majority of its actual or target readers if you included a goddam definition of “opportunity costs”?

Is the point of this blog to inform, or is it just that the bloggers wants to publicly look down their noses at everyone else?

Aaron Chalfin September 2, 2005 at 10:16 am

Many of them probably didn’t read the question carefully.

michael vassar September 2, 2005 at 10:36 am

Random answers imply more than not reading carefully.
Monetary motivations have historically proven ineffective in eliciting correct answers to simple logic problems. Even large monetary motivations do so among Chinese peasants.
I think that readers of this blog should know opportunity cost, or how to use google, rather than expecting it to be spoon-fed to them.

JC September 2, 2005 at 10:45 am

I was one of the subjects of this study at the 2005 AEA meetings. I was on the job market and had gone to the 4th floor of the hotel to check on where my interviews were going to be. As you might imagine, I was incredibly stressed out and distracted. I was then approached by somebody who wanted me to fill out this form. I can’t remember what I answered (hopefully, the right answer!), but I do remember thinking (a) this seems like a trick question, so the obvious answer is probably not the right answer, and (b) this is the last thing I want to be doing right now.

Rob September 2, 2005 at 10:55 am

Perhaps I am getting too hung-up in the fact that this question used aged performers, but it seems to me it ignores the opportunity cost of never seeing Dylan if you see Clapton and vice versa.

Lou September 2, 2005 at 11:06 am

From the NYT article you also learn the shocking figure that if you are a student you were over twice as likely to get the correct answer (although still less likely than guessing randomly) if you had never taken an economics class.

One other note, I got the question right, but I wonder if I would have had Alex not empahsized ‘this is not a trick’. I can imagine being confronted with a similiarly straightforward Physics question at an APS conference and overthinking it because I couldn’t understand why anyone would bother with such a simple question. But, none the less, this is a question with only one right answer and I’m stunned that so many experts got it wrong. I’d have guessed it should be 80%+.

Desert Island Boy September 2, 2005 at 11:09 am

I nearly said it was a trick question, because I said to myslef, it’s not on here, the answer is -10. Then I looked it over and had to spell out what was what. Aaron Chaflin is right, the question needs to read quite carefully.

The biggest problem in teaching economics is understanding perspective and relationships. You can summarize all the theory you want, but the semantics in defining scenarios is very important.

That said, I am sure that even if half of those who got it wrong could potentially have got it right, it woul still have been a professional embarrassment…

josh September 2, 2005 at 11:29 am

I don’t understand why your WTP for Clapton tix wouldn’t be included.

The opportunity cost for seeing Dylan should be your WTP for Dylan minus the price of the ticket minus the net benefit from seeing Clapton.

Regardless, after just seeing Dylan, my opportunity cost of seeing him over Clapton would be high. The guy didn’t pick up a guitar once!

Robert Cote September 2, 2005 at 11:48 am

Perhaps so many got the “correct” answer “wrong” because of the slippery meaning of “on any given day.” The hypothetical was not about any given day but a day when there was a competing event with unstated value and prefered tickets priced below their percieved value.

For this example the two outcomes are; see Clapton and have $40 in pocket aquiring some unknown experince value or see Dylan and have nothing in pocket and $50 of experience.

IMHO the correct answer is that there are some things economics cannot model.

Paul N September 2, 2005 at 12:05 pm

Alex’s outrage is silly. You can’t use a single tricky question to judge the whole state of economics in the USA.

It may be reassuring to hear an anecdote that implies that most highly-educated economists are idiots, but you’re being very sloppy if you let one anecdote overthrow your entire perspective on the way things are.

roversaurus September 2, 2005 at 12:26 pm

I’ve been thinking and reading other posts. I do understand a little better how you are trying to define opportunity costs.

You gave up the ability to grab
10$ in “value” that you would have gotten by going to the Dylan concert.

And in thinking about this more I think the premise is bogus and the attempt to give a “value” isn’t really accurate.

Read the premise again:
“On any given day, you would be willing to pay up to $50 to see Dylan”

That is untrue. On THIS day you
would NOT be willing to pay $50 for the ticket. The evidence is obvious – you DIDN’T pay $50 for the ticket. That makes the calculation of 10$ pretty bogus to me.

University College London September 2, 2005 at 12:41 pm

Right,

The difficulty in the question is to pay attention to the bit ” UP TO 50 $ “, which actually says that your NET utility from the Dylan concert would be zero after paying 50.

From there on, it’s an easy deduction.

joshg September 2, 2005 at 12:54 pm

roversaurus:

You have the opportunity to pick up a bill off of the ground for free. Your second best option would be to pay $40 to go and pick up a $50 bill from some really stupidly run business. Assuming you don’t mind the work inovolved in picking up either bill, what is the opportunity cost of picking up the first bill?

The answer is obvious. It is what you are giving up, ie. what it COSTS you to not do whatever else you would have done. The net cost is $10.

Also, while you would chose to go pick up a $20 bill for free in this instance; the statement, “on any given day you would be willing to pay $50 to go pick up a $50 bill (if you were indiferent to the actual picking up) still has obvious meaning.

Timothy September 2, 2005 at 2:06 pm

Does it matter if I prefer Clapton, or if I really can’t stand his music?

Timothy Dreier September 2, 2005 at 2:16 pm

Just wanted to point out that I am the original “Timothy” and the one at 2:06 isn’t me. As to his question, no, it doesn’t change the dynamics other than in the case of the latter it implies that the marginal benefit you’ll get from Clapton is < the Opportunity Cost of seeing him, and thusly you would elect to buy the Dylan ticket.

roversaurus September 2, 2005 at 2:24 pm

Joshg,

Thank you that was a very clarifying example.

For my kids the opportunity cost of the chocolate ice cream is
still the whole value of the vanilla because they are getting both for free.

This would mean that children whine more about missing vanilla when it is free as opposed to when they have to pay for it.
The opportunity costs are greater when both chocolate and vanilla are free.

Still I have never heard of opportunity costs being given a monetary value and I think the stricter definition limits the usefulness in conversation.

Timothy September 2, 2005 at 3:07 pm

Thanks, Timothy Dreier, from Timothy . Nice flow of comments on this one.

Dan September 2, 2005 at 4:22 pm

An economist and a banker were crossing the street on the way to lunch. The banker said “look, there’s a $20 bill on the pavement”. The economist said “that can’t be a $20 bill; if it were really a $20 bill, someone would already have picked it up. You can’t expect to find $20 bills on the pavement in big cities.” The banker stopped, looked at the economist then stooped over and picked up the $20 bill; they went on to lunch.

George September 2, 2005 at 4:31 pm

A more persuasive test of an understanding of opportunity cost would be to ask “you and a co-author can write a paper about a trivial question you asked of slightly toasted economists at cocktail parties at the AEA meetings OR you could write a substantive paper about real economics that might have a chance in a credible journal.”

Similarly, we could ask all those AEA economists who didn’t go to GMU to examine the opportunity costs underlying Alex’s comment “if you really want to learn economics come to GMU. I guarantee that your professors understand opportunity cost.” My sense is that others understand even better:

GMU:
http://www.gmu.edu/departments/economics/grad/alums.html
MIT:
http://econ-www.mit.edu/graduate/career.htm
Stanford GSB:
http://www.gsb.stanford.edu/phd/fields/econ/placements.html
Berkeley:
http://emlab.berkeley.edu/econ/grad/placement.shtml
Yale:
http://www.econ.yale.edu/graduate/placement/outcomes.htm

Seems like when it actually matters, “the world’s best economists” get it right.

Matt Rochlin September 2, 2005 at 6:07 pm

AMBIGUOUS: This is not a straightforward question. Because Clapton is a reasonable substitute for Dylan (as an equivalent source of entertainment at a given time), the question could be interpreted as: Given a choice of equally entertaining diversions worth $50 to you on a given evening costing either $0 or $40, what is the opportunity cost of forgoing the $40 entertainment for the $0 entertainment? In that case, the answer would be zero (there was no sacrifice of net benefit). To make the question unambiguous, the forgone opportunity should not be a viable substitute for the opportunity taking its place. For example, if someone across town from the Clapton concert was handing out $10 coupons for a FUTURE Dylan concert, the opportunity cost would not be ambigous.

Mark Gilbert September 2, 2005 at 6:40 pm

Seems to me the answer is $10 plus whatever benefit I would get by paying $50 to go see Bob Dylan. If paying $50 erased all the benefit of seeing Dylan, I WOULDN’T GO SEE HIM. But, the question tells me that I would go see him, so there must be some benefit to doing so.

The question is fine, and the answer isn’t complicated. It’s the suggested multiple choice answers that reduce all calculation of costs and benefits to dollars that seem silly. Isn’t life more complicated than that?

Eric September 2, 2005 at 7:24 pm

Mark,

$10 is the benefit that you receive by seeing Dylan. There are no other benefits from seeing Dylan.

Tom,

The opportunity cost of a choice (go to see Clapton) is the value of the alternative that you give up (go to see Dylan) if you WERE to make that choice (go to see Clapton). The value of the Clapton concert is irrelevant in calculating the value of what you would give up if you decided to go.

tomhynes September 2, 2005 at 9:39 pm

We have one data point that says economists are idiots; let’s not over extrapolate. If you run an experiment and get totally surprising results, run it again before you publish the results.

Some Other Tom September 2, 2005 at 10:10 pm

Eric says: “The value of the Clapton concert is irrelevant in calculating the value of what you would give up if you decided to go.”

Yes, I think the problem many are having is that the Clapton choice has no explicit monetary value (in fact, it’s explicitly said to have no monetary resale value), while the Dylan choice is given both explicit $ value and $ cost. When applying the concept in real life (e.g., considering among two or more alternative capital investments) all choices are assigned (if imperfectly) some monetary value, even the “do nothing” alternative. Yet here going to see Clapton is the equivalent of a “do nothing” decision, yet is assigned no value (other than saying that Dylan is “next best”).

If “Clapton” was replaced by some obviously dissimilar good of unstated value (staying home watching Law & Order reruns, reading economics blogs, etc.), or the question was very simply stated as “What is your opportunity cost of not seeing Dylan if he is worth $50 to you and a ticket costs $40″, there would probably be more correct answers.

My instant reaction to the question was the correct answer, but it only took me two milliseconds to start over-thinking/doubting based on re-reading the question. Namely: (1) no statement of the $ value to me of the Clapton ticket (and the words “next best” suggest to me that Dylan is of lesser, not equivalent, value than Clapton); and (2) it does not say Dylan is absolutely, in any circumstances, “worth $50″ to me, it says I would pay “up to” $50 suggesting that my Dylan-philia exists on some sliding scale, maybe depending on what else is going on that night.

So it may not be a “trick,” but it is certainly insufficiently disambiguated!

Ragout September 3, 2005 at 1:04 am

Alex,

I’m not aware of a rigorous definition of opportunity cost & I notice you don’t give one.

If you go by the concept discussed in intro econ text books, the answer is clearly $50. For example, the opportunity cost of college is the foregone earnings from a job. Not: the foregone earnings minus the disutility of labor.

To quote an intro textbook: “if a pizza restaurant hires a waiter, the wages paid are … the opportunity cost.” (Parkin, 3rd edition, p. 200) Not: the wages paid minus the worker’s productivity.

In other words, opportunity cost means gross cost, not net cost. Perhaps you’re right that net costs are a more sensible thing to think about, which would imply that the textbooks ought to be changed, but you’re wrong about what opportunity cost means.

s9 September 3, 2005 at 5:18 am

Many of them probably didn’t read the question carefully.

That makes it more embarrassing.

smuggler September 3, 2005 at 5:54 am

After further investigation, it looks like the problem is with econ texts, as the authors of this study acknowledge. They read definitions in 9 texts and find that “seven out of nine do not provide the reader with enough information to answer our opportunity cost question correctly.”
That is, the standard definition in texts is along the lines of “value of the next-best, alternative.” Therefore, an answer of $50 is pretty understandable, even though it is wrong.

Don September 3, 2005 at 7:06 am

Yet Another Tom:

If you go to see Clapton, you can’t also go and see Dylan at the same time. So the cost of seeing Clapton is the foregone opportunity to see Dylan. Your net enjoyment from seeing Dylan, according to the problem, is $10 — the $50 worth of enjoyment you’ll get minus the $40 it’d cost you. That’s what you’re giving up to see Clapton.

Lockjaw:

If you value Clapton at $60, you’d certainly be acting optimally by going to see him, as you would enjoy a net benefit of $50. The term “opportunity profit” isn’t used to describe this benefit, but you have the right idea.

Don

Matthew McIrvin September 3, 2005 at 10:48 am

Holy cow, I got it right and I had to guess what “opportunity cost” meant.

Bill Woolsey September 3, 2005 at 12:10 pm

I am a GMU educated Ph.D. economist, and
I got the answer wrong. I picked $50, though
I didn’t spend more than a few seconds in getting it
wrong.

The definition of opportunity cost is the most
important alternative sacrificed. I did know that.

I suspect that most economists would have picked
that definition over alternatives like “money spent
on resources needed to produce a product,” or “the
labor time needed to produce the product” or
“the market price.”

Now, one might wonder if economists really know
what “opportunity cost” means if they
can’t apply it.

But the problem here wasn’t a simple application.
A simple application would be something like–smith
has a dollar. He can buy a coke, a candy bar, or
keep the dollar. While the coke is his first
choice, the candy bar is is second choice.
Keeping the dollar is his least important priority.

What is the opportunity cost of the coke (the utility
from, that is subjective evaluation of, consuming
the candy bar.

The concert scenario involves one option of enjoying
Clapton and something one might buy for $40, say,
a fancy dinner vs. the alternative of enjoying Dylan.

The opportunity cost of Clapton and the dinner is enjoying
Dylan. That is the utitity from (subjective evaluation of)
seeing Dylan.

The opportunity cost of Dylan is Clapton and a nice dinner–
the utility from or subjective evaluation of–both of those
things together.

But the question is what is the opportunity cost of Clapton
alone.

So, we have to figure that we can move the fancy dinner over to
the opportunity cost side. That is, the opportunity cost of
Clapton is the utility from Dylan minus the utility from
the steak dinner. This works with cardinal utility. Not a
common view among economists these days. In the
example, “utility” was replaced by willingness to pay.

So, the opportunity cost of enjoying Clapton and the
dinner is what you would be willing to pay for
Dylan ($50)

The opportunity cost of Dylan is what you would
be willing to pay for Clapton and the dinner together.

The oppotunity cost of Clapton alone is what one
would be willing to pay for Dylan less what
one would be willing to pay for the dinner.

Not obviously correct, but it might be the best
answer. (That is, if we all agreed to define
opportunity cost in terms of the amount of money
people would be willing to pay for the most important
alternative sacrificed.)

Of course, the “problem” is that we didn’t know
about the steak dinner or what one would be
willing to pay for it. We just had the price
of the Dylan ticket.

And so, we have the “right” answer being the
consumer surplus from the next best purchase.
Perhaps the best answer, but not obviously
correct. It mixes the logic of choice with
consumer surplus calculated from market prices.

One final note–the two constraint nature of the
question–money and time–made it complicated too.
Usually, economists deal with consumption situations
where you can consume any combination of goods.
Clapton one night, then Dylan the next, I suppose.

In conclusion, we cannot assume that the economists
didn’t know what opportunity cost meant.

They just aren’t very good at applying the situation
to an ambiguous situation and agreeing with a “best”
approach.

decon September 3, 2005 at 2:11 pm

Thank God for your answer Spencer. Consumer surplus = 10. Opportunity cost = 40.

MilongaMan September 3, 2005 at 3:43 pm

So, what IS a good definition?

And please state it in mathematical terms, as much as possible. It can’t be that hard.

BTW, I am not an economist, just a physicist, but my 14-year old son was reading a college textbook on economics and this “opportunity cost” is astonishingly badly explained. It seems like the textbook in general is trying to avoid math (*) much as possible, which only makes matters worse in my view.

Thanks in advance!

(*) save for the many 2-d graphs

spencer September 3, 2005 at 5:16 pm

Smullger — I agree completey with your definiton of opportunity costs.

But that does not make your anwser correct.

I said the opportunity costs was the alternative use of the $40.
That is in complete agreement with what you said.

But the Clayton concert is not an alternative use of the $40 because it is free.

Now if you had asked what was the opportunity cost of my time
you would be right. But that is not what the question asked.

The example is very, very poorly written. The reason it is poorly written is
because the correct answer
is not given. The correct answer is what is the alternative use of the $40
and that is not given.

It is a classic example of a teacher giving a poor example
and not understanding why the students do not get it.

spencer September 3, 2005 at 5:59 pm

Smuggler — good point, you are right.

But in this case the opportunity cost is $0
because your alternative is doing something that
costs you nothing.

Your alternative to spending $0 on the free
concert is not spending $40 on something else.

josh September 3, 2005 at 6:41 pm

I agree with Spencer. Relative prices reveal opportunity cost. Say your consumption is limited to seeing one of the two shows. Put your constraint into point slope form and you have Y=(M/pY)-(pX/pY)*X. This shows that the opportunity cost of seeing Clapton, if Clapton is good X, is actually zero.

Patrick R. Sullivan September 3, 2005 at 8:59 pm

I agree with spencer and the others who are trying to separate the consumer surplus of $10 in going to see Dylan, from the idea of opportunity costs. If we’re going to use consumer surplus to calculate opportunity cost, then we need to know the surplus from going to see Clapton. And the question doesn’t produce that crucial piece of information.

If we in fact go to see Clapton that would seem to reveal our preference (that we value it at SOMETHING). Further, going to see Clapton would seem to indicate that we value it at at least $10.

Steve LaBonne September 3, 2005 at 11:43 pm

Patrick, here’s what you’re confused about. Yes, obviously the $10 is your net benefit (“consumer surplus”) if you go to hear Dylan. Opportunity cost is the net benefit of doing X that is _foregone_ if you do Y instead. In this case, what you’re forgoing by hearing Clapton is that $10 “consumer surplus” from hearing Dylan. That _does not change_ depending on how much you value hearing Clapton. The significance of the latter is simply that if Clapton is worth more than $10 to you you should hear Clapton, otherwise not, but in any case you’re _always_ forgoing that $10 Dylan benefit. There is no ambiguity and it’s not a trick question, nor is there any doubt about the correct answer if you actually know the definition of “opportunity cost”. This is not anything abstruse but absolutely fundamental to economic rationality. I’m no economist and even I know this.

Talkativeman September 4, 2005 at 2:52 am

The first serious discussion of opportunity cost I read was from James Buchanan’s “Cost and Choice.” I always thought it was he who introduced the notion and the term, although he also uses the term “choice-influencing cost.” His explanation was so simple and lucid, I never had to read any other text. Actually it is that term “choice” and how Buchanan tied it to the term “cost” that got me thinking seriously about the parallels in the thinking of an engineer vs. marketer (or rather the difference). My major is not economics and I don’t think I ever attended any economics class. Be that as it may, my understanding resonates with that of “prestopundit” as far as the immeasurability of opportunity cost goes.

Raj (Talkativeman)

joshg September 4, 2005 at 2:00 pm

good for you, name usurper.

Rastus September 4, 2005 at 5:11 pm

…the ‘original’ Clapton/Dylan problem was edited & condensed by those conducting the referenced survey (…see the actual PDF survey document URL at the beginning here).

So there may well have been a lost-in-translation/wording issue causing some confusion here.

Here are excerpts from that actual survey document:

“..The opportunity cost question we presented to respondents was adapted from page 4 of Robert Frank and Ben Bernanke’s textbook, Introduction to Microeconomics (2001), and was presented exactly as follows to ASSA survey respondents… We simplified the question by paring the text and rendering the format multiple-choice rather than open-ended. We also made the question more precise by writing that there are no other costs involved other than those stated in the question…”

{note: They don’t state the ‘original’ Frank & Bernanke question text in full}

Here’s how the survey guys explained their $10 answer:

“… to state why $10 is the opportunity cost of seeing Eric Clapton. When you go to the Clapton concert, you forgo the $50 of benefits you would have received from going to the Dylan concert. You also forgo the $40 of costs that you would have incurred by going to the Dylan concert. An avoided benefit is a cost, and an avoided cost is a benefit. Thus, the opportunity cost of seeing Clapton, the value you forgo by not going to the Dylan concert, is $10 – i.e., the net benefit forgone…”

————

So any ‘avoided benefit’ is a cost ??

I must be accumulating huge ‘costs’ by not clipping/using all those store coupons I see in newspapers/magazines ??

ogmb September 6, 2005 at 3:38 am

Was there an individual penalty for giving a wrong answer? No? Question answered.

DC September 7, 2005 at 11:38 am

Let’s also note that “to cost” is an irregular verb in English, and “c-o-s-t” is the spelling of both the present and past tense of “to cost”. Some economists may have interpreted this ambiguous homograph in different ways.

To avoid confusion, consider alternative clarifying phrasings of the question using the past perfect vs. the future tenses.

If the ticket “had cost” $40, this $40 cost is sunk — and the true opportunity cost of Clapton is $50. If the Dylan ticket “will cost” $40, these costs are not sunk, and the true opportunity cost is $10. My hypothesis (which y’all are welcome to test) is that this revised version of the question would trick many, many fewer people.

I made a separate comment focusing on the sunkenness yesterday, but this morning is the first time I noticed the semantic ambiguity!

P.S. I is a native English speaker. I note, mildly, that the AEA is not composed 100% of native-English speakers, and this “cost” vs “cost” formulation would be a puzzler to many of us, whether native English-speakers or not.

DC September 7, 2005 at 4:47 pm

Let’s also note that “to cost” is an irregular verb in English, and “c-o-s-t” is the spelling of both the present and past tense of “to cost”. Some economists may have interpreted this ambiguous homograph in different ways.

To avoid confusion, consider alternative clarifying phrasings of the question using the past perfect vs. the future tenses.

If the ticket “had cost” $40, this $40 cost is sunk — and the true opportunity cost of seeing Clapton instead of Dylan is $50. If the Dylan ticket “will cost” $40, these costs are not sunk, and the true opportunity cost of seeing Clapton instead of Dylan is $10. My hypothesis (which y’all are welcome to test) is that this revised version of the question would trick many, many fewer people.

Yeah, that’s what I shoulda said the first time.

Gavin Kenendy September 9, 2005 at 3:36 am

In negotiation, a similar idea to that of opportunity cost is advocated, known as ‘BATNA’, the Best Alternative to No Agreement’ (I have slightly amended the original formulation from Roger Fisher and Bill Urry, of Harvard in their book: ‘Getting to Yes’, 1982).

The advice is given as a criterion of judgement in deciding whether to accept or reject the other party’s offer. If your best alternative to rejecting the offer is ‘better’ than what is offered – if, for instance, you have a better offer available from somebody else, say – then you should reject the offer, unambiguously. Your BATNA gives you the ‘strength’ to say ‘no’ (or, more politely, ‘no thank you’, or even more politely, ‘thanks, but no thanks’).

Now, germane to this discussion, how do you know that the offer from across the table is better or worse than your best alternative? Well, one way is to compare them. If the offer from across the table is worth $40 and your best alternative was worth $50, then you would be advised to reject the $40 offer and take the $50 offer you could get elsewhere. Why? Because $50 is bigger than $40 by the amount of $10.

Whether you think of this as an opportunity cost of $50 or of $10 makes no difference to the decision. Leaving it at $50 means you have not completed (maybe not needed to complete: the important point is $50>$40) the reasoning for why you should choose $50 over $40, mainly because the point might be considered too obvious to complete the arithmetic.

For the advocates of $10 to show that answering $50 is wrong, they would have to show that in such a comparison a mistake could be made; for the advocates of $50 to show that $10 is wrong they would have to show that the comparison of $50 with $40 is a different comparison from saying $10.

Methinks this is one of those economists’ quibbles of no real significance or at least no great importance.

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