Think about a choice you just made: the decision to begin reading this right now rather than use your time to study for another course, play sports, watch TV, play video games, go online, get some sleep, hang with friends, or do something else. Suppose it’s late and your best alternative to reading right now is getting some sleep. The cost of reading is passing up the opportunity of sleep. Because of scarcity, whenever you make a choice, you must pass up another opportunity; you must incur an
opportunity cost.
opportunity Cost What do we mean when we talk about the cost of something? Isn’t it what we must give up must forgo to get that thing? The opportunity cost of the chosen item or activity is the value of the best alternative that is forgone. You can think of opportunity cost as the opportunity lost. Sometimes opportunity cost can be measured in terms of money, although, as we shall see, money is usually only part of opportunity cost. How many times have you heard people say they did something because they “had nothing better to do”? They actually mean they had nothing else going on. Yet, according to the idea of opportunity cost, people always do what they do because they have nothing better to do. The choice selected seems, at the time, preferable to any other possible alternative.
opportunity cost.
opportunity Cost What do we mean when we talk about the cost of something? Isn’t it what we must give up must forgo to get that thing? The opportunity cost of the chosen item or activity is the value of the best alternative that is forgone. You can think of opportunity cost as the opportunity lost. Sometimes opportunity cost can be measured in terms of money, although, as we shall see, money is usually only part of opportunity cost. How many times have you heard people say they did something because they “had nothing better to do”? They actually mean they had nothing else going on. Yet, according to the idea of opportunity cost, people always do what they do because they have nothing better to do. The choice selected seems, at the time, preferable to any other possible alternative.
Opportunity Cost Is Subjective
Like beauty, opportunity cost is in the eye of the beholder. It is subjective. Only the individual making the choice can identify the most attractive alternative. But the chooser seldom knows the actual value of what was passed up, because that alternative is “the road not taken.” If you give up an evening of pizza and conversation with friends to work on a research paper, you will never know exactly what you gave up. You know only what you expected. Evidently, you expected the benefit of working on that paper to exceed the benefit of the best alternative. (Incidentally, focusing on the best alternative forgone makes all other alternatives irrelevant.)
Calculating Opportunity Cost Requires Time and Information
Economists assume that people rationally choose the most valued alternative. This does not mean you exhaustively assess the value of all possibilities. You assess alternatives as long as the expected marginal benefit of gathering more information about your options exceeds the expected marginal cost (even if you are not aware of making such conscious calculations). In other words, you do the best you can for yourself. Because learning about alternatives is costly and time consuming, some choices are based on limited or even wrong information. Indeed, some choices may turn out badly (you went for a picnic but it rained; the movie you rented stunk; your new shoes pinch; your new exercise equipment gets no exercise; the stock you bought tanked). Regret about lost opportunities is captured in the common expression “coulda, woulda, shoulda.” At the time you made the selection, however, you thought you were making the best use of all your scarce resources, including the time required to gather and evaluate information about your choices.
Time: The Ultimate Constraint
The Sultan of Brunei is among the richest people on earth, worth billions based on huge oil revenues that flow into his tiny country. He and his royal family (which has ruled since 1405) live in a palace with 1,788 rooms, including 257 bathrooms and a throne room the size of a football field. The family owns hundreds of cars, including dozens of Rolls-Royces; he can drive any of these or pilot one of his seven planes, including the 747 with gold-plated furniture. Supported by such wealth, the Sultan would appear to have overcome the economic problem of scarcity. Though he can buy just about whatever he wants, he lacks the time to enjoy all his stuff. If he pursues one activity, he cannot at the same time do something else. Each activity involves an opportunity cost. Consequently, the Sultan must choose from among the competing uses of his scarcest resource, time. Although your alternatives are less exotic, you too face a time constraint, especially as the college term winds down.
Opportunity Cost Varies With Circumstance
Opportunity cost depends on your alternatives. This is why you are more likely to study on a Tuesday night than on a Saturday night. The opportunity cost of studying is lower on a Tuesday night, because your alternatives are less attractive than on a Saturday night, when more is going on. Suppose you go to a movie on Saturday night. Your opportunity cost is the value of your best alternative forgone, which might be attending a college game. For some of you, studying on Saturday night may rank well down the list of alternatives perhaps ahead of reorganizing your closet but behind doing your laundry. Opportunity cost is subjective, but in some cases, money paid for goods and services is a reasonable approximation. For example, the opportunity cost of the new DVD player you bought is the benefit from spending that $100 on the best forgone alternative. The money measure may leave out some important elements, however, particularly the value of the time involved. For example, watching the latest hit movie costs you not only the $10 admission price but also the time needed to get there, watch the movie, and return home.
Like beauty, opportunity cost is in the eye of the beholder. It is subjective. Only the individual making the choice can identify the most attractive alternative. But the chooser seldom knows the actual value of what was passed up, because that alternative is “the road not taken.” If you give up an evening of pizza and conversation with friends to work on a research paper, you will never know exactly what you gave up. You know only what you expected. Evidently, you expected the benefit of working on that paper to exceed the benefit of the best alternative. (Incidentally, focusing on the best alternative forgone makes all other alternatives irrelevant.)
Calculating Opportunity Cost Requires Time and Information
Economists assume that people rationally choose the most valued alternative. This does not mean you exhaustively assess the value of all possibilities. You assess alternatives as long as the expected marginal benefit of gathering more information about your options exceeds the expected marginal cost (even if you are not aware of making such conscious calculations). In other words, you do the best you can for yourself. Because learning about alternatives is costly and time consuming, some choices are based on limited or even wrong information. Indeed, some choices may turn out badly (you went for a picnic but it rained; the movie you rented stunk; your new shoes pinch; your new exercise equipment gets no exercise; the stock you bought tanked). Regret about lost opportunities is captured in the common expression “coulda, woulda, shoulda.” At the time you made the selection, however, you thought you were making the best use of all your scarce resources, including the time required to gather and evaluate information about your choices.
Time: The Ultimate Constraint
The Sultan of Brunei is among the richest people on earth, worth billions based on huge oil revenues that flow into his tiny country. He and his royal family (which has ruled since 1405) live in a palace with 1,788 rooms, including 257 bathrooms and a throne room the size of a football field. The family owns hundreds of cars, including dozens of Rolls-Royces; he can drive any of these or pilot one of his seven planes, including the 747 with gold-plated furniture. Supported by such wealth, the Sultan would appear to have overcome the economic problem of scarcity. Though he can buy just about whatever he wants, he lacks the time to enjoy all his stuff. If he pursues one activity, he cannot at the same time do something else. Each activity involves an opportunity cost. Consequently, the Sultan must choose from among the competing uses of his scarcest resource, time. Although your alternatives are less exotic, you too face a time constraint, especially as the college term winds down.
Opportunity Cost Varies With Circumstance
Opportunity cost depends on your alternatives. This is why you are more likely to study on a Tuesday night than on a Saturday night. The opportunity cost of studying is lower on a Tuesday night, because your alternatives are less attractive than on a Saturday night, when more is going on. Suppose you go to a movie on Saturday night. Your opportunity cost is the value of your best alternative forgone, which might be attending a college game. For some of you, studying on Saturday night may rank well down the list of alternatives perhaps ahead of reorganizing your closet but behind doing your laundry. Opportunity cost is subjective, but in some cases, money paid for goods and services is a reasonable approximation. For example, the opportunity cost of the new DVD player you bought is the benefit from spending that $100 on the best forgone alternative. The money measure may leave out some important elements, however, particularly the value of the time involved. For example, watching the latest hit movie costs you not only the $10 admission price but also the time needed to get there, watch the movie, and return home.
Even religious practices are subject to opportunity cost. For example, about half the U.S. population attends religious services at least once a month. In some states, socalled blue laws prohibit retail activity on Sunday. Some states have repealed these laws in recent years, thus raising the opportunity cost of church attendance. Researchers have found that when a state repeals its blue laws, religious attendance declines as do church donations. These results do not seem to be linked to any decline in religiosity before the repeal
Sunk Cost and Choice
Suppose you have just finished grocery shopping and are wheeling your cart toward the checkout counters. How do you decide which line to join? Easy. You pick the one with the shortest expected wait. Suppose that line barely moves for 10 minutes, when you notice that a cashier has opened a new one and invites you to check out. Do you switch to the open cashier, or do you think, “Since I’ve already spent 10 minutes in this line, I’m staying put”? The 10 minutes you waited represents a sunk cost, which is a cost that has already been incurred and cannot be recovered, regardless of whatyou do next. You should ignore sunk costs in making economic choices.
Sunk Cost and Choice
Suppose you have just finished grocery shopping and are wheeling your cart toward the checkout counters. How do you decide which line to join? Easy. You pick the one with the shortest expected wait. Suppose that line barely moves for 10 minutes, when you notice that a cashier has opened a new one and invites you to check out. Do you switch to the open cashier, or do you think, “Since I’ve already spent 10 minutes in this line, I’m staying put”? The 10 minutes you waited represents a sunk cost, which is a cost that has already been incurred and cannot be recovered, regardless of whatyou do next. You should ignore sunk costs in making economic choices.
Hence, you should switch lines. Economic decision makers should consider only those costs that are affected by the choice. Sunk costs have already been incurred and are not affected by the choice, so they are irrelevant. Likewise, you should walk out on a bad movie, even if you spent $10 to get in. Your $10 is gone, and sitting through that stinker only makes you worse off. The irrelevance of sunk costs is underscored by proverbs such as “Don’t throw good money after bad,” “Let bygones be bygones,” “That’s water over the dam,” and “There’s no sense crying over spilled milk.” The milk has already spilled, so whatever you do now cannot change that. Or, as Shakespeare’s Lady Macbeth put it, “Things without all remedy should be without regard: what’s done is done.” In other words, get over it. Now that you have some idea about opportunity cost, let’s see how it helps solve the economic problem.
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