Do economists understand the concept of opportunity cost?

by on January 16, 2012 at 3:51 am in Economics, Education, Philosophy | Permalink

Remember those old debates on MR as to what opportunity cost is exactly supposed to mean?  Joel Potter and Shane Sanders have an interesting follow-up paper:

Abstract: Ferraro and Taylor (2005) asked 199 professional economists a multiple-choice question about opportunity cost.  Given that only 21.6 percent answered “correctly,” they conclude that professional understanding of the concept is “dismal.” We challenge this critique of the profession. Specifically, we allow for alternative opportunity cost accounting methodologies—one of which is derived from the term’s definition as found in Ferraro and Taylor— and rely on the conventional relationship between willingness to pay and substitute goods to demonstrate that every answer to the multiple-choice question is defensible. The Ferraro and Taylor survey question suggests difficulties in framing an opportunity cost accounting question, as well as a lack of coordination in opportunity cost accounting methodology.  In scope and logic, we conclude that the survey question does not, however, succeed in measuring professional understanding of opportunity cost.  A discussion follows as to the concept’s appropriate role in the classroom.

NAME REDACTED January 16, 2012 at 4:27 am

Answer: no.
Hrm, do they split between macro, health, IO, Labor etc? It would be interesting to hear which field understands and which doesn’t.

Pierre-Louis January 16, 2012 at 5:35 am

The same could be said about comparative advantage. I’d say more than 50% of economists, even within trade economists, don’t understand the concept…

Willitts January 16, 2012 at 2:33 pm

Since comparative advantage is defined by relative opportunity costs, the questions are one and the same.

Andrew' January 16, 2012 at 7:08 am

Opportunity cost questioners don’t understand opportunity cost questions.

Claudia January 16, 2012 at 8:28 am

Summary…framing and context matters both in surveys and in real life. I am always skeptical of economist surveys (we are not representative of decision makers in “the wild”), but these important points stand out even among economists. An interesting extension would be to do some cognitive interviewing where you ask people how they interpreted the question and formed their answer. Not a common technique in economics but often more illuminating than introspection.

Rahul January 16, 2012 at 8:40 am

This was the original question; and it still confuses the crap out of me. I went with A which is the “wrong” answer. Wonder how MR commentators do?

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 D. $50

Claudia January 16, 2012 at 8:48 am

Rahul, I got hung up on the question too, since someone would have to pay me to sit though an Eric Clapton concert. But I know firsthand how hard it is to write survey questions about economic concepts. (You should see my attempts at Ricardian equivalence.) I still think this is an interesting exercise.

Rahul January 16, 2012 at 9:41 am

Ironically, the more I read the article the more confusing it gets. I think the article sure succeeded in making my pre-existing notion of opportunity cost fuzzier.

Anyways, for fun I made a quick poll.

http://bit.ly/Opportunity_Cost_Poll

Curious to see what’s the MR opinion convergence on this question.

Andrew' January 16, 2012 at 10:57 am

Opportunity cost questioner questioner questioners don’t understand opportunity cost questioner questioners.

Rahul January 17, 2012 at 4:01 am

Guess MR readers are smarter than the average economist; 75% went for the “correct” answer. (n=22)

k January 18, 2012 at 2:32 pm

MR readers smarter than econ phds.

says more about econ phds than it does about MR.

rpl January 16, 2012 at 9:18 am

If you don’t mind sharing, what was your rationale for choosing ‘A’? To me, it’s the one answer that is obviously wrong after the briefest glance. To say that the opportunity cost is zero is to say that there is literally nothing else you could be doing with your time that produces some value above its costs. Considering the number of things that are basically free that produce at least some modest enjoyment, that seems implausible to me.

My first impulse was to say ‘D,’ but then I remembered the $40 cost of the ticket, which you must deduct from the $50 utility of seeing the Dylan concert.

Rahul January 16, 2012 at 10:09 am

Oh, I am nowhere close to being an economist. So my rationale would be useless. Anyways I was going by a narrow definition. Something like:

“Revenue forfeited by alternative use of time or facilities” or
“net revenue from the best alternative course of action.”

As the alternative revenue stream was zero as was the actual cost of Clapton; I set the opportunity cost to zero. I took it to assume Dylan and Clapton were the only options in his universe, of course. If the alternative was selling hot-dogs for 4 hours and earning $200 I’d had have chosen $200 as the answer. If additionally, the taxi fare to Clapton was $20 I’d have said that the opportunity cost of Clapton was $220.

Guess that’s naive, eh? I thought it’s only “revenue” and “cost” streams that go in and out and not “value” streams.

Marcos January 16, 2012 at 1:07 pm

Thanks, I was quite convinced it was D. I was wrong.

That is indeed a confusing question. I had to read it a few times.

Willitts January 16, 2012 at 3:07 pm

Well then the definition should be correctly stated as “the NET value of the next best alternative forgone from the next best alternative,” not merely for clarity of meaning but precision in definition.

Suppose you have two alternative concerts: Dylan which costs $40 and you value at $50, and Sting which costs $20 and you value it at $40.

You place a higher value on Dylan than Sting, but your net value for Sting is higher at $20. Note that the value you place on Clapton isn’t stated in the question. Because we know it is preferred, it doesn’t need to be stated. You KNOW its value to you is at least $10.01.

The scenario is contrived to be a one time opportunity. It also assumes thin indifference curves. The economist in me prefers Clapton, but the music lover in me says that if my GROSS value of Dylan is nearly five times higher than my GROSS value of Clapton, I’m going to see Dylan.

The marginal utility per dollar of anything free is infinite. The guy who chooses to see the free Clapton concert has the same marginal utility per dollar of sitting at home watching dust settle on his coffee table: infinity. Clearly we are not indifferent to all things with the same marginal utility per dollar! The Clapton goer chose Clapton over every other free thing available to him. It must have added the most marginal utility irrespective of its price.

The example is poor not merely because there are differences in interpretation, but rather because our model of human behavior based on price and marginal utility and alternative choices is somehow flawed. Do humans really consume the product with the highest marginal utility per dollar? It appears that preferences are far more complex, especially in a dynamic situation.

We assume that the value placed on each concert includes all of the future enjoyment we get from remembering it, and incorporates future opportunities to see all concerts. Things may be abundant in the present and scarce over time.

ian January 16, 2012 at 11:08 am

i got hung up on this until i realized that the final sentence leaves out the word “choice”. if you aren’t expressing a preference for Clapton over Dylan, you are simply “seeing Eric Clapton” (because that is the way the researchers determined it), then indeed the opportunity cost is $10.

Jeff January 16, 2012 at 5:48 pm

It’s not a trick question, and I don’t understand why anyone is confused by it. The opportunity cost of going to the Clapton concert is what you give up by doing so. That’s the definition of opportunity cost. In this case, the alternative was going to see Dylan, which you value at $50 but have to shell out $40 to do. The net value of the alternative is thus $10. What’s so hard about that?

What I think is really going on here is that an awful lot of economists don’t actually know the definition of opportunity cost. That is sad.

Steve January 17, 2012 at 12:56 pm

What’s “hard” about it is that OC is an accounting device and people don’t agree on it’s definition. OC is just supposed to help people answer questions like “will he see the Clapton concert or the Dylan concert?” which is a very simple example kind of question utility theory was thought up to answer. I don’t think anyone would get THAT question wrong if enough information were provided to answer it.

You seem to think that the only way to get it right is to say “ok I value Clapton at X, I value Dylan at [$50 minus $40 cost of ticket =] $10, so I go if X > 10″ but plenty of people are smart enough to solve it by saying “ok I value Clapton and $40 at X, I value Dylan at $50 so I go if X+40 > 50.” The later is how most people do cost-benefit analysis in real life, list all the benefits on the left and all the costs on the right and just find the net benefit as a sufficient statistic, so it shouldn’t shock anyone that that’s how most people solved the problem too.

Also, for clarify, “what you give up by doing so” is not clear definition but you didn’t even mention it’s giving up the next best alternative! How could that be considered a clear definition?

Jeff January 17, 2012 at 2:22 pm

OC is not an accounting concept, it’s an economic one. The people who were surveyed were all Econ PhDs or soon would be. The fact that so many of them didn’t know the definition of opportunity cost, a basic concept in economic analysis, is a strong indictment of the content of graduate training in economics.

Jeff L January 17, 2012 at 8:12 pm

Is $10 really the opportunity cost? I would think that ($10 + value of a normal night) is the real opportunity cost, since the preference to see Dylan is also relative to whatever you’d be up to on any normal night. So perhaps many economists think that $10 dollars is too low and end up picking one of the other “wrong” answers.

MK January 16, 2012 at 9:09 am

An economist, while he was a frustrated former grad student at one of the top schools, once said “carpenters produce something tangible like tables. Economists, on the other hand, raise extremely important questions but never succeeded in providing indisputable answer even to one of them.” I wonder what the average opportunity cost of being an economist has been these days

Jeff January 16, 2012 at 6:01 pm

Well, since he was frustrated perhaps he can be forgiven for such a dumb statement.

There are a whole bunch of things economists know and agree on. Price controls are bad ideas. So are trade restrictions. Arbitrage happens. Demand curves slope down. Inflation is always and everywhere a monetary phenomena.

Yes, you can find people who will dispute every one of these assertions. Some of them even call themselves economists. But they are not using economic reasoning when they dispute them. Heck, even physics, the most successful science, has cranks who dispute fundamental tenets of the standard model, mostly because they don’t actually understand it. Why should economics be any diffferent?

MK January 17, 2012 at 4:07 am

Jeff I agree with “Arbitrage happens. Demand curves slope down. Inflation is always and everywhere a monetary phenomena.” However, ” Price controls are bad ideas. So are trade restrictions.” are normative statements based on some notion of welfare comparison. I bet the results “Arbitrage happens. Demand curves slope down. Inflation is always and everywhere a monetary phenomena.” were known before 50s.

Jeff January 17, 2012 at 2:28 pm

But the only economists you will find who favor price controls and/or trade restrictions are those who are paid to take such positions. That says more about them as individuals than it does about economics.

MK January 18, 2012 at 3:43 am

Leaving the issue of who gets paid for what aside, those are normative statements, period. If you have an economics with a reasonable “social welfare” function that passes the aggregation test, then enlighten us. It’s uninteresting diversion of the idea that arbitrage happens if you think the justification is wall street finances such types of research. The goal of positive economics is not to favor or disfavor some policies; it is to understand the how the real world works. I don’t doubt that minimum wage reduces employment. However, but the judgment “good” or “bad” reflects value judgment of some people and not ALL the people. Bottom line, keep the positive economics unmixed with value judgement until you have a good understanding of “social” justice and welfare.
Speaking of the opportunity cost, if you think you have a good quality bread that you have produced these days, then show me the bread!

Brian Donohue January 16, 2012 at 9:34 am

If you think about the context of the question and the facts given, I don’t see how any economist worth his salt who understands the concept of opportunity cost doesn’t recognize what the question is driving at and answers $10. I can imagine some screwball semantics junkies demurring, but, looking at the random distribution of the answers, and the fact that $10 was least chosen, makes me want to facepalm.

LarryM January 16, 2012 at 9:44 am

Agree. I’m not an economist – though with some long ago undergraduate academic background thereof – and the “correct” answer of $10 struck me immediately as the obviously correct answer.

Rahul January 16, 2012 at 10:36 am

Isn’t $10 just the “consumer surplus”( if I did go to Dylan)?

Or is that a coincidence?

Ryan P January 16, 2012 at 10:57 am

Yep. It’s not a coincidence. The cost of going to Eric Clapton is that you don’t get the Dylan surplus

dw January 16, 2012 at 2:27 pm

Is it just me or does the question leave out vital information — the consumer surplus for the Clapton concert (or how much I would pay to go see Clapton). Are we supposed to assume it’s $0?

dw January 16, 2012 at 2:42 pm

NVM, just re-read Ken Rhodes’ comment and it makes sense now.

dearieme January 16, 2012 at 9:37 am

Do economists understand the concept of opportunity cost?

Why would opportunity cost be in a category of its own?

Cliff January 16, 2012 at 10:23 am

This paper makes no sense to me. I do not find their arguments in favor of the “wrong” answers at all convincing. If they are right that there is no standard definition for opportunity cost, that also makes no sense. The concept would be pretty useless if applied in the alternate ways they have suggested.

Dale January 16, 2012 at 10:50 am

I also find the article’s defenses for responses other than $10 less than convincing. However, this reminds me of the first article I attempted to publish (30 years ago) – which was summarily rejected.
A book publisher’s rag at the time had an article about how even Presidents of the US don’t understand basic economics – it cited (then) President Carter’s statement that in response to rising oil prices, people insulate their homes and the demand for electricity had dropped. The article then pointed out how it is the “quantity demanded” for electricity that has dropped in response to a supply shift.

What I observed was that if posed as a multiple choice questions (responses: demand drops, quantity demanded drops, both, neither) most students would get it “wrong” and the best students in an introductory economics course would be more likely to get it wrong. The reason is due to the missing component of time – the article’s approach is correct for a short run analysis, but not a long run analysis. Surely, when a home is insulated, the demand for electricity drops for any time period except for the very longest (where the insulation can wear out and not be replaced). In fact, the short run analysis may apply most realistically to the relevant facts when there is a sudden supply shock (as in the 1970s) but the long run analysis would apply if we were analyzing what would happen if the price of oil (the supply shock) were to decrease after homes had been insulated. The point in my manuscript was that multiple choice questions were not a good way to teach economics.

That would be my point for this opportunity cost exercise as well. The “best arguments” may yield incorrect answers. Absent a chance to explain your answer for credit, there is simply no way for a multiple choice question to measure anything other than your ability to take tests. It will not test economic knowledge. It is even damaging, as a more nuanced understanding could result in a student throwing up their hands and saying “I can’t understand this, so I guess I’m not very good at this subject.”

I’ve always wondered why my manuscript was rejected. And why this one on opportunity cost makes it into the SEJ. Perhaps it is because my bottom line was “multiple choice questions are not a good way to teach economics” and this article’s bottom line is “economists really do understand opportunity cost.” Have I become too skeptical over the course of my career?

Marcos January 16, 2012 at 1:14 pm

Yes, you’ve come too skeptical.

Both articles had different results because they were reviewed by different people, with different expectations. Also, they have different details and styles so one could easily satisfy the same group of people, while the other doesn’t.

There is a huge chance factor in getting an article through review.

mlc January 16, 2012 at 11:08 am

Barely an economist, but I’ll give this a whirl…

You basically have an opportunity to see a free Clapton concert, and you cannot re-sell the tickets-so we’re dealing with found money, or utility from seeing Clapton, as it were, since the tickets have no monetary value. Your alternative is to see Dylan for $40, apparently a show which you would gladly pay $50 to see, which is irrelevant because we are comparing something which costs money with something that doesn’t.

Assuming you gain an equal amount of utility from each, I read this as “I can go to a free concert, or pay $40 for a different concert.” What have I given up in order to see Clapton for free? The opportunity to pay for the same amount of utility, so I’ve given up nothing to see a free show. So I answered A. However, it does not surprise me that the formalized textbook answer completely misses the point of the real life situation. Any other answer than $0 is absurd, since you are not really trading money in this case, you are trading the happiness gained from paying to see Dylan for the opportunity to see Clapton for free.

Turning the question on its head: if you paid to see Dylan, go to see him, then later find out that you could have seen Clapton for free, what is your opportunity cost of paying to see Dylan?

If I’m off base then someone please explain how, because this really bothers me for some reason…

Marcos January 16, 2012 at 1:21 pm

You can’t assume both give you the same utility. Anyway, that is irrelevant, the question is about what you lose by going to the Clapton show, not what you gain.

Yes, you lose happiness, not money. But happiness has a value, proof of it is that you’d pay for it. On that specific case, your happiness is postulated to be worth $50 (that’s mind blowing, I agree, but economics say that). Since you’d have to pay $40 to get $50 worth of happiness, you’d gain $10 from the transaction. That is what you are losing because you’ll go to the other show.

Willitts January 16, 2012 at 3:28 pm

No, the definition of opportunity cost PRESUMES you made the BEST choice because of the words “next best alternative.” Clapton is revealed preferred to Dylan at the prices of $0 and $50 respectively.

What’s becoming clear is that our definition of opportunity cost is unclear. We present the topic in a complete vacuum of context in how choices are made. Without that context, we can’t determine how we arrived at the “values” we placed on the respective choices.

In utility theory, we allocate our scarce budget such that we first choose the good that maximizes marginal utility per dollar. In this example, the MU/P of a Clapton concert is infinity. But suppose there was a Pink Floyd concert valued at $70 at a cost of $50. This would imply the value of Clapton is at least $21.01. The choice of Clapton PRECLUDES any other choice with a price and value combination that is greater than a Clapton concert for zero dollars. But everything else that is free has the same MU/P. There must at least be a second condition that whenever MU/P is equal, you choose what provides the highest MU. Sensible enough, but we are left with an inadequate representation of choice and value.

There is something awry either with our definition of opportunity cost or the feasibility of the question posed.

michael January 16, 2012 at 11:24 am

i chose $0, too… the grammar of the question is horrible. if you look back in the old thread, you’ll see what’s wrong with the question’s phrasing. there are also several assumptions, most importantly that the utility from each concert is equal…

Laserlight January 16, 2012 at 1:52 pm

The utility and costs for the Clapton show are irrelevant. The question is, what are you giving up by not seeing Dylan? You’re giving up $50 worth of enjoyment, but you’re not paying $40 for the ticket either, so your net opportunity cost is 50-40 = 10.

Willitts January 16, 2012 at 3:32 pm

Value, not utility. $50 is the value you place on the utility of seeing the Dylan concert.

Ken Rhodes January 16, 2012 at 11:52 am

The main thing this thread shows is that economists — the ones who made up the silly question and the ones here trying to answer it — simply don’t understand accounting.

Opportunity cost is NOT the “bottom line” cost, it is just one of the components of the bottom line. The net value from a choice, which is what some answers addressed, has nothing to do with opportunity cost. It is the value received minus the “actual” cost to get that value. So if you can get a ticket to Dylan for $40 and the value to you is $50, making that choice creates a net gain for you of $10. It has not one thing in this world to do with what any of myriad other options might have gained or lost to you.

OTOH, the “total cost” of attending the Dylan concert would be the “actual cost” of $40 plus the “opportunity cost” of foregoing your best alternative. If that best alternative would be attending the free Clapton concert, then the “opportunity cost” of foregoing the Clapton concert has NOTHING to do with the cost of the Clapton ticket to other folks who had to buy theirs. Rather, it is the value you forego minus the cost you don’t have to pay. Since the cost to you would have been zero, the “opportunity cost” (which is one component of your “total cost”) is the value *to you* you had to forego.

Economists should study accounting.

Willitts January 16, 2012 at 3:33 pm

That’s funny, because the chief criticism of accounting is that until recently it was oblivious to opportunity costs.

Ken Rhodes January 16, 2012 at 5:07 pm

That’s true, but for this “reverse” reason–accounting is merely a tool set to answer a lot of financial questions. If you know the right question to ask, and you have the right accounting tools, then you will likely find the right answer.

“Opportunity cost” as a component of decision-making is an *input* to the decision-making process. The accountant can tell you how to calculate it, but it ain’t his job to tell you how to use it, or why.

RK January 16, 2012 at 1:00 pm

$10 dollars is intuitively right to me. You get 10 extra dollars of utility by going to the Bob Dylan concert. You’d choose to go to the Clapton concert only if the Benefit outweighed the costs In this case, the only cost is the opportunity cost of going to Dylan, resulting in the rule that you’d only go to Clapton if he’d give you at least $10 of utility. Though I suppose I agree with these authors that any accounting that results in that decision could be technically correct.

However, another question for the group: from my long ago econ classes, I remember learning that Willingness to Pay is your stand-alone reservation price — basically the intrinsic value of utility you’d receive from that choice. And also that it was a really bad choice of a name, because while your *economic* WTP for a choice never changes unless your tastes change, your “willingness” to buy something in the everyday sense of the word changes based on the calculation of [WTP minus Price] and compared to other [WTP minus price] options. This paper says that WTP for one item decreases when another becomes more attractive. Is that the general understanding? Do I have it wrong?

Willitts January 16, 2012 at 3:44 pm

Utility is measured in a notional unit of utils.

The $50 is the VALUE you place on a certain number of utils.

V=f(U) where U is the total utility you get from seeing the concert. U is a function X where X is the vector of consumption goods and leisure. U typically increases at a decreasing rate for each good in the vector, holding all else constant.

The function f is somewhat mystical and not necessarily well behaved. The example given in the question imposes a lot of restrictions on U and f.

Eric January 16, 2012 at 11:34 pm

Also, utils can’t be measured in absolute terms (cardinal utility) but rather in a ranking compared to other options (ordinal utility). WTP is a good proxy but in the real world many utility choices can’t be boiled down to a WTP number just a preference for one option over another.

Economics January 16, 2012 at 1:08 pm

This blog entry considers a defense of “other” answers:

http://marginalrevolution.com/?s=September+5%2C+2005

Neal January 16, 2012 at 2:11 pm

If every presented solution is defensible given the questioners’ definition and the solutions are mutually contradictory, is “opportunity cost” well-defined?

bleh January 16, 2012 at 2:16 pm

op cost is somewhat a ridiculous concept. sure you can come up with answers that make sense to this particular question, and similar questions everywhere found on econ 1 or 2 quizzes everywhere…

Say you live in NYC or some other populous local — to calculate your opportunity cost for seeing Clapton, do you consider the hundreds of other music shows playing in town at the same time? Calculate that you could be spending that time walking in the park, eating a fancy dinner, seeing a play, going out with friends, working an extra few hours, spending time writing something that may or may not be published, on and on and on? Opportunity cost resembles an infinite summation, and the terms you are summing over are generally unknown and possibly unknowable — what is the $ value of having a deep conversation with your best friend about an immediate emotional trauma?

At least you can see how it tends towards ridiculousness — on any given day whether I see any given show does not relate to some perfect utility function that maps out “I’d be willing to pay 50$ to see Dylan” and “I’d be willing to pay 5$ transit to walk on the beach and shop for caviar in Boyton” and so on. I don’t consider that I actually might pay 10.50$ to see Clapton, and get dressed to go, feeling 50 cents happy. If I am feeling cheap, maybe I don’t want to see Clapton for 5$ one day, and the next I may be willing at 15$. Utility changes every day, and even the act of measuring it (in $) changes it.

Willitts January 16, 2012 at 3:57 pm

I think you raise a good point. Microeconomists can argue forever over how to calculate opportunity cost. What’s truly meaningful is that professionals and laymen understand that opportunity costs EXIST. It leads to the basic intuition of TANSTAAFL and the eternal dismay of politicians.

We know from this example that the value placed on Clapton is AT LEAST $10.01. By examining larger choice sets, we can more precisely discover the minimum value of the Clapton concert for this person. If we examine his choices over time, controlling for other prices and income, we could either precisely determine his value of the concert (with preferences fixed) or map his preferences (with value fixed).

Ed January 16, 2012 at 4:30 pm

I’ve skimmed through the comments but I think you guys are overthinking the Bob Dylan question.

I’m going to restate the question more clearly. You are willing to pay $50 to go to a Bob Dylan concert. If you can go to a Bob Dylan concert for $40, what is the opportunity cost if you don’t go?

Put that way, the question is easy, so the Eric Clapton stuff is thrown in to make it harder. With my question, you just have to know what opportunity cost is. The way the question is phrased, you have to also be able to navigate your way through a semi-trick question.

Its a semi-trick question because presumably you also have some value for going to the Eric Clapton concert, though it may be negative. A better question would incorporate the value for going to the Eric Clapton concert andy ask for the net opportunity cost.

“You won a free ticket to see an Eric Clapton concert, which normally you would pay $30 to go see. 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. Someone offers to buy your Eric Clapton ticket for $20. Based on this information, what is the opportunity cost of seeing Eric Clapton?”

This is probably a harder question without the trickery of the original, though I think my easier version tests the concept of opportunity cost fine, the harder version just adds more accounting.

Rahul January 16, 2012 at 5:15 pm

The Eric Clapton stuff changes the question

Willitts January 17, 2012 at 3:46 am

No, the question is “What is the opportunity cost of going to Clapton?” The presumption of the question is that you are going to Clapton as your most-preferred choice. The concept of opportunity cost presumes you choose the best option because we all know you are a rational person.

Since the net value of Dylan is $10, then you MUST value Clapton at $10.01 or more (since the price is 0). We don’t know how much you value Clapton, but we know your lower bound.

If you value Clapton at $30, this satisfies the statement of the original question. Then along comes another person who offers you $20 for it (Why? I don’t know. Neither do you.). Why would you sell a ticket for $20 if you value it at $30? Dylan was in your choice set, so you have at least $40 already. You don’t need the $20 to expand your choices.

If you go to Clapton, your opportunity cost is $20 because selling the ticket at $20 is better than going to Dylan for a net of $10. We must assume that selling the ticket occupies the time you would have spent at the concert otherwise we have compound choices.

Adding the information you did only muddies the waters further and raises more “what ifs.” The answer is also sensitive to the value you place on Clapton and the value the other person offers you. The original question wasn’t tricky; it just shows our definition of opportunity cost is imprecise.

Anshuman January 16, 2012 at 7:20 pm

Who the hell uses word in 2012?? Why aren’t these guys using Latex (or something) to create pdfs?

rahul January 17, 2012 at 7:45 pm

I know. The paper would take on a whole new meaning in Latex.

Anshuman January 18, 2012 at 12:14 pm

haha you’re supposed to be a funny man?? You’re missing the point. In Finance, pdfs made from Latex or whatever else are the industry standard. Seminar participants and other people whose feedback you want have a very high opportunity cost of time and wading through a paper with muddled ideas takes a lot of brain power and time. So the last thing you want is for formatting distractions to take away from your work and irritate the reader. For example, take a look at the Journal of Finance papers. Look at how beautiful the tables are, how there are no vertical lines. Those tables are dense with information and you want the reader to only focus on the numbers and not be distracted by bad formatting. Or other conventions like using x,y,z for variables and a,b,c for parameters. Changing these things won’t change any content but would make your paper annoying to read. The idea is not to make things pretty but to take away formatting distractions and have the focus solely on the content. A few hours of Latex can enable anyone to do that.

Bangecon January 16, 2012 at 9:44 pm

Let me ask this: If the Dylan ticket carried a price of $50, would the opportunity cost be zero, and would A.T. defend that answer?

Willitts January 17, 2012 at 3:47 am

That is a great question.

JETHRO January 16, 2012 at 11:25 pm

Just stick to the opportunity cost questions in the test bank and you don’t have to worry about it.

justin January 17, 2012 at 1:47 pm

The revealing thing about this question is the lengths to which many economists will rationalize their wrong answer with technical jargon. It’s a microcosm of the whole profession, I think.

Physicist’s response to the realization his answer was wrong: “Oops.”
Economist’s response: “Well if I assume X and Y, and marginal this and that, and some utility function, really the answer is D. Actually, the question is flawed. On an unrelated note, economics is too a science and we should support proposal Z to loot the masses for the public good.”

Yancey Ward January 17, 2012 at 4:28 pm

Exactly. I get the impression that economists are the sorts of students that nag professors/teachers endlessly for extra credit on wrong answers.

Economics January 17, 2012 at 7:43 pm

You’re exactly right. There is no such thing as a bad question.

Anshuman January 18, 2012 at 12:32 pm

You’re wrong in drawing that conclusion. The point is that there is no consensus on a precise definition of an opportunity cost that can work in many contexts. Everyone understands that it’s about trade-offs due to scarcity and choice but different accounting methods can capture the same tradeoffs (for example, linear transformations are order preserving under certain conditions). The New Palgrave economics dictionary states that ” Opportunity cost is the evaluation placed on the most highly valued of the rejected alternatives or opportunities.”

The 2005 paper used net gain to measure this. Some economists used personal valuation , some used market price to measure it and some others might use return on investment to measure it once you make sure to control for the risk involved in the investment.

Justin January 21, 2012 at 3:45 am

If a train leaves Los Angeles at 6am and travels at an average speed of 70 mph to arrive at a destination 100 miles away, should you use relativistic equations of motion or explore all of the quantum possibilities to determine when the train will arrive? Should you model the possibility that there could be a train accident? Maybe you should just answer the question in the obvious, straightforward way and not make a big stink if you make an error doing long division.

There is nothing in the question that would lead one to believe that a discussion of whether linear transformations are order preserving is relevant. Seriously, read what you just wrote and then go back and read the original question and see if your statement passes the smell test.

Anshuman January 21, 2012 at 4:59 pm

Justin,

I don’t want to get lost in bad analogies. Let’s stick to the topic here. The concept of opportunity cost is about scarcity and how choices made imply opportunities foregone and the opportunity cost of a particular choice is either the private value or personal value or market price or return or net benefit of the best choice foregone, all the while controlling for risk in some fashion. Apparently there isn’t a consensus on how to measure it but all of these measures are just translations of each other and will preserve an agent’s order structure (hence the comment about linear transformations). Like the author of the second paper, I agree that any of the above methods can be used to get a handle on the value of the foregone opportunity.

Urso January 17, 2012 at 3:59 pm

I’m 99% sure this question was in the first chapter of my econ 101 textbook, right down to Dylan and Clapton being the choices. All I could think was “these guys need to update their examples.”

rahul January 17, 2012 at 7:47 pm

funny

Ryan January 18, 2012 at 2:40 pm

I actually believe that all of the answers are incorrect based on the wording of the question. Given the wording, I value the Clapton concert more than any other alternative. This sentence implies that the value of the Clapton concert is at least $10 ($50-40 of the next best alternative Dylan). In order to attend the Dylan concert I would have to give up my $10 + benefit from the Clapton concert to gain a maximum of $10 net benefit from the Dylan concert. In other words you would have to pay me to attend the Dylan concert. You could also make the assumption that the Clapton concert is worth more than $50 ($50 a $0) and therefore you’d have to pay me more than $40 to give up the Clapton ticket to see Dylan.

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