Ec101: Understanding Opportunity Costs

I mean, come on. Who doesn’t understand opportunity costs?

The cost of the next best alternative, of the opportunity foregone. We could have told you this in our sleep.

So answer me this (and please don’t cheat):

“Imagine that you have a free ticket (which you cannot resell) to see Radiohead performing. But, by staggering coincidence, you could also go to see Lady Gaga – there are tickets on sale for £40. You’d be willing to pay £50 to see Lady Gaga on any given night, and her concert is the best alternative to seeing Radiohead. Assume there are no other costs of seeing either gig. What is the opportunity cost of seeing Radiohead? (a) £0, (b), £10, (c) £40, or (d) £50.”

1. That is from Tim Harford, and is unfortunately behind an FT paywall. But here’s the original paper.
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   “We were surprised by the diversity of opinion regarding the value to which the
   term “opportunity cost” applies. As Table 2 indicates, the most popular answer
   was $50, with 27.6% of respondents choosing this answer. The second most
   popular answer was $40, with 25.6% of respondents choosing this answer. The
   third most popular answer was $0, with 25.1% of respondents choosing this
   answer. The correct answer, $10, was the least popular, with only 21.6% of
   respondents choosing this answer. In essence, the answers given to us by well trained economists appear to be randomly distributed across possible answers.” (Emphasis added)
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   So what did you guess?
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2. People got plenty upset about the whole thing – check the comments, especially,
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3. “I don’t have any quarrel with Alex’s economics; as far as I can see this point is semantic. (I’ll also admit that my gross perspective on opportunity cost is somewhat anachronistic; it is one reason why mainstream economists work directly with consumer surplus.) What disturbs me is how few economists gave $50 or $40 as the right answer; the actual answers were close to randomly distributed. Most Web-based sources appear confused on the net vs. gross issue, but at least they hover across the $40 and $50 options.”
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   Economists don’t always agree, but it mostly comes to down to splitting hairs? If only it were so…
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4. “This paper analyzes the relationship between opportunity costs of waiting and bribery in rationing by waiting situations. Assuming that a uniform waiting time clears the market for any given bribe and the bureaucrat chooses a bribe to maximize profit, the market equilibrium is characterized in terms of individual valuations of the good and opportunity costs of waiting. If individual valuations take discrete values and opportunity costs of waiting are uniformly distributed, then in an equilibrium individuals with low costs of waiting choose to wait while those with high opportunity costs pay the bribe”
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   While traveling on India’s highways, have you ever seen trucks waiting by the highway for no apparent reason?
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5. For interested students, a big fat list of examples, drawn from multiple walks of life.

Author: Ashish

Blogger. Occasional teacher. Aspiring writer. Legendary procrastinator. View all posts by Ashish