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Opportunity Cost
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.
Posted by Alex Tabarrok on September 2, 2005 at 07:15 AM in Economics | Permalink
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Comments
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.
Posted by: The Eclectic Econoclast at Sep 2, 2005 7:58:05 AM
That was my answer, but it seemed so easy that I was really nervous about it. Can I have a PHD for that?
Posted by: josh at Sep 2, 2005 8:00:00 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)...
Posted by: Joe M. at Sep 2, 2005 8:36:17 AM
So if the Dylan Ticket were to cost $50, there would be no opportunity cost
in going to the Clapton show. Which do you attend?
Posted by: craig at Sep 2, 2005 8:36:46 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
Posted by: Bob at Sep 2, 2005 8:53:29 AM
I said $50 too; in fairness to the profession, most of them probably did what I did, which was to think that you could go to the Dylan concert for free too. Yes, I know it says "Tickets to see Dylan cost $40," but on a careless reading that could mean "...for all those suckers who don't get to see it for free."
So slag economists for careless readiing, not bad economics. Try re-wording the sentence to "Tickets to see Dylan, whom you may not see for free, cost $40." I'll bet that will generate correct answers close to 100% of the time.
Posted by: Tom at Sep 2, 2005 8:53:53 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?"
Posted by: Slocum at Sep 2, 2005 8:53:57 AM
Craig- if the Dylan ticket cost $50 it very well might no longer be your next-best alternative activity (as you derive no gain from buying the ticket and attending the concert), and so might no longer be the proper measuring-stick.
On the other hand, as others said: if Dylan and Clapton really were your only two options, you would choose Clapton as long as you place any positive value on hearing Clapton (since Dylan give you no gain). If you dislike Clapton and would rather NOT hear him, you would choose Dylan. If you were truly indifferent between hearing Clapton and no hearing Clapton (unlikely), then you would also be truly indifferent between attending Clapton and attending Dylan (as there is no net gain or loss from either activity). Unless we introduce transaction costs at some level or another...
Posted by: Joe M. at Sep 2, 2005 8:55:15 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.
Posted by: Joe M. at Sep 2, 2005 8:59:25 AM
Sorry for so many comments, but I meant to say: the fact that the question is worded confusingly doesn't explain all of the problem. Remember, the answers weren't evenly split between $50 and $10 -- they were more or less evenly distributed across the four answers. I don't see how confusing wording fixes this -- how do you misread the question to get an answer of $0? So I don't think you get 100% correct even with better wording.
My hypothesis stands: busy people perform poorly on meaningless tasks. If you want have 100% correct answers, buy them lunch if they get the answer correct. Now that's a study I'd like to see.
Posted by: Joe M. at Sep 2, 2005 9:04:23 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! ;-)
Posted by: Turuk at Sep 2, 2005 9:17:34 AM
Priorities. I remember 2 professors, one saying to me the most important thing to know is the Envelope Theorem, the other Girsanov's Theorem. Simple, profound ideas are often lost in the focus on sexy, technical ideas that separate Great Economists from the great unwashed. Hooey. As Feynman said about physics, if you can't explain it to an undergrad, you don't understand it.
Posted by: eric at Sep 2, 2005 9:36:26 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?
Posted by: Peter K. at Sep 2, 2005 9:45:20 AM
Good grief.
Posted by: Mike at Sep 2, 2005 9:51:53 AM
Many of them probably didn't read the question carefully.
Posted by: Aaron Chalfin at Sep 2, 2005 10:16:57 AM
Peter K.: I discovered and understood the concept by reading the following definition:
http://en.wikipedia.org/wiki/Opportunity_cost
Posted by: Turuk at Sep 2, 2005 10:28:14 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.
Posted by: michael vassar at Sep 2, 2005 10:36:26 AM
I have a question now: what is the opportunity cost of seeing Dylan?
I guess it requires an additional piece of information: the price you would be ready to pay to see Clapton.
Correct?
Posted by: Turuk at Sep 2, 2005 10:40:33 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.
Posted by: JC at Sep 2, 2005 10:45:45 AM
Why would I pay $40 to see Dylan if I considered Dylan to be 'next-best' compared to seeing Clapton?
Posted by: Andrew Gleadall at Sep 2, 2005 10:47:03 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.
Posted by: Rob at Sep 2, 2005 10:55:40 AM
I think the missing piece of information for $10 to be the correct answer is that you can still see Dylan for $50 another night. In real life, concerts are rarely played in the same place, and therefore the costs of missing the Dylan concert is not the extra $10 you have to pay, but a) the extra costs in time and money to travel to see him elsewhere, or b) (if you cannot see Dylan at all on another night) the full $50 cost that you were willing to pay to see Dylan is actually correct.
Posted by: Stephen Duncan Jr at Sep 2, 2005 11:06:35 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%+.
Posted by: Lou at Sep 2, 2005 11:06:36 AM
I got it wrong!. But then again thats why I am a scientist not an economist. I see the value of the clapton tickets as 50 dollars, since youd pay 50 to see dylan, but you are seing clapton instead.
Posted by: callmemickey at Sep 2, 2005 11:09:00 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...
Posted by: Desert Island Boy at Sep 2, 2005 11:09:14 AM
In thinking about it, in my previous scenario b) I suppose the opportunity cost should be $40, not $50, but that difference goes to the definition of monetary cost (market value vs. personal value), and is not a difference, primarily, of knowing what opportunity cost is, as opportunity cost is not an essentially monetary concept, and indeed frequently it's difficult to express the monetary cost...
Posted by: Stephen Duncan Jr at Sep 2, 2005 11:17:57 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!
Posted by: josh at Sep 2, 2005 11:29:28 AM
D'oh! I normally consider myself somewhat economically literate (though I'm not an economist). But I got it wrong! I figured, I'm giving up $50 worth of utility, so the opp cost is $50. Forgot to net. Damn net, you've screwed me again!
Posted by: redfaced at Sep 2, 2005 11:40:34 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.
Posted by: Robert Cote at Sep 2, 2005 11:48:58 AM
Josh: The question is about the opportunity cost of seeing Clapton not Dylan, which makes the WTP for Clapton irrelevant given that the ticket was free. Your net gain on seeing Clapton will be WTP(Clapton)-$10 because the ticket was free, but that's not what the question was about.
The answer is (b), I've only a BS in Econ, and something like this was an exam question in my very first intro micro class. Let me repeat that: a question very much like this one was an exam question in my INTRO MICRO class as an undergraduate. I was 18 years old, and halfway through an intro class, and I got this right. It is not a hard question, this is a question that a small child should be able to answer. That is a professional embarassment, and unlike some other commenters, I'm not going to excuse it for poor reading. It's clearly worded, it doesn't have to be read all that carefully, and it took me about ten seconds to answer. Maybe profs aren't used to not having an answer manual handy, who knows.
As for graduate school, there is no question that if/when I go I'll aim for GMU, supposing I can persuade the nice folks in admissions to let me in. Perhaps I can persuade them that the opportunity cost of studying more during my undergrad was high enough to make drinking beer at the pub much more appealing.
Posted by: Timothy at Sep 2, 2005 11:55:12 AM
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.
Posted by: Paul N at Sep 2, 2005 12:05:37 PM
Then I have been explaining opportunity costs wrongly for quite some time (I guess it's good that I'm not a professor).
I have always stated that the opportunity cost is the choice you didn't make. If you choose to eat chocolate ice cream then vanilla ice cream is the opportunity cost. You can not have both. So the opportunity cost is the whole value of the thing you gave up. You gave up the entire experience of vanilla ice cream in order to eat chocolate.... So I guessed $50. I still think I'm right.
One reason is that if the actual price of the Dylan tickets had been $50 that would make the opportunity cost zero. Meaning NO
opportunity cost.
In the words of Ineqyo Mantoya (sorry for the spelling)
"You keep using that word. I do no thin' it means what you thin' it means."
So what is the correct term for
what *I described? What do I tell my kids when they whine about not being able to do two things at once?
Posted by: roversaurus at Sep 2, 2005 12:11:48 PM
I've been thinking and reading other posts. I do understand a little better how you are trying to define opportunity costs.
You gave up the ability to grab
10$ 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.
Posted by: roversaurus at Sep 2, 2005 12:26:43 PM
I just want to point out that there are two "josh"s here. I was the fist one who posted. I think I will now switch to joshg.
Posted by: joshg at Sep 2, 2005 12:36:00 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.
Posted by: University College London at Sep 2, 2005 12:41:28 PM
An answer from a social scientist: what is the opportunity cost of participating in research?
The participants are wasting their time, they could be blogging instead of participating ... so they dont read the question correctly, and answer wrong. Nothing less, nothing more. Again an illustration of the beauty of surveys. Time is a scarse good.
Posted by: alex le roy at Sep 2, 2005 12:48:12 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.
Posted by: joshg at Sep 2, 2005 12:54:43 PM
I got stuck on trying to figure out why in the world the Clapton tickets would have "no resale value," and just stopped reading. I mean, c'mon, even Molly Hatchet reunion tickets have resale value!
Posted by: R.J. Lehmann at Sep 2, 2005 1:21:46 PM
Does it matter if I prefer Clapton, or if I really can't stand his music?
Posted by: Timothy at Sep 2, 2005 2:06:12 PM
If you value a Dylan concert at $50 and you only pay $40 you would have a $10 consumer surplus. By seeing the free Clapton concert ($0) or not going to the Dylan concert for any reason your opportunity cost for what you choose to do is the $10 CS.
You dont even need the first part of the question to get the correct answer. Hence, it is a poorly worded question. If the question had read:
Tickets to see Bob 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 the performer. Based on this information, what is the opportunity cost of not seeing the Dylan concert? (a) $0, (b) $10, (c) $40, or (d) $50.
I bet there would have been overwhelmingly more correct answers. Any decent teacher knows that trick questions rarely test the subject matter at hand. Instead they only show which students carefully read the questions.
I half expected to look at the article and see that is was written by sociologists. The professional embarassment is that 2 economists would create this crappy of a question and expect to get accurate results. Opportunity cost is not a difficult concept, but like anything it can be convoluded in a crappy question and made much harder by disconnected elitist professors. Congratulations Ferraro and Taylor you have proven some of the more pedantic points of academia.
Posted by: J.M. Josephson at Sep 2, 2005 2:16:05 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.
Posted by: Timothy Dreier at Sep 2, 2005 2:16:09 PM
Frank is wrong. The opportunity cost of seeing Clapton is the value of the next most highly valued action foregone, seeing Dylan, which is $40, the cost of the ticket.
The fact that someone might pay $50 is irrelevant because it's not demonstrated in his action.
The $10 is just a mirage, a figment of Frank's imagination.
Since he couldn't get into the Dylan concert for $10, it's daft to see that as the opportunity cost. Trivial bs exercises like this are one of the three things I hated most about economics as an undergrad, the other two being hydraulic Keynesianism, and the abuse of math and the hero worship of false second-rate math idols like Samuelson.
Posted by: Bill Stepp at Sep 2, 2005 2:20:45 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.
Posted by: roversaurus at Sep 2, 2005 2:24:31 PM
Roversaurus:
You have actually hit on an intersting point in Economics right now. Many want to start looking at opportunity cost as something more concrete instead of an abstract concept. This is done by looking at loss of Consumer Surplus or Net Benefit. It applies a lot to public economics and looking at the opportunity cost of different allocation of resources and putting a dollar ammount on it to make the most fiscally responsible decisions in the public sector.
Posted by: J.M. Josephson at Sep 2, 2005 2:30:52 PM
Thanks, Timothy Dreier, from Timothy . Nice flow of comments on this one.
Posted by: Timothy at Sep 2, 2005 3:07:00 PM
There's a missing component to this equation: what am I *willing* to pay to see Eric Clapton?
The net benefit here is essentially what I am willing to pay less what I actually pay. The opportunity cost would be the net benefit of Dylan *minus* the net benefit of Clapton, wouldn't it? So I need to know what I am willing to pay for Clapton, from which we deduct nothing to produce a net benefit.
So perhaps what these professors are saying is "you would need to pay ME forty dollars to see a Clapton concert". That makes the benefit of the Clapton concert -40, and with the net benefit of Dylan being 10, we subtract the benefit of the Clapton concert to give a result of $50.
And given *my* respective opinions on Clapton and Dylan, this actually seems like the most plausible explanation. ;)
Posted by: Caliban Darklock at Sep 2, 2005 4:14:37 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.
Posted by: Dan at Sep 2, 2005 4:22:58 PM
Opportunity cost isn't net benefit. It is part of the cost associated with making a decision not the profit.
Posted by: joshg at Sep 2, 2005 4:26:14 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.
Posted by: George at Sep 2, 2005 4:31:51 PM
Opportunity cost is forgone net benefit.
Posted by: J.M. Josephson at Sep 2, 2005 4:57:23 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.
Posted by: Matt Rochlin at Sep 2, 2005 6:07:22 PM
Per Wikipedia (which many readers have cited): "Opportunity cost is a term used in economics, to mean the cost of something in terms of an opportunity foregone (and the benefits that could be received from that opportunity), or the most valuable foregone alternative." Now, assume that I derive equal enjoyment from Eric Clapton and Bob Dylan's music (enjoyment -- benefits -- being a critical dimension of the problem not mentioned in the original post). If I see Eric Clapton for free and the only alternative use of my time was to see Bob Dylan for $40, then the opportunity cost of seeing Eric Clapton was -$40. So my answer is "(e) none of the above."
Posted by: Tom at Sep 2, 2005 6:16:41 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?
Posted by: Mark Gilbert at Sep 2, 2005 6:40:20 PM
The common sense answer is obviously $0, since there really is no cost to you at all if you go to the Clapton show.
But I understand the formal concept of opportunity cost (or thought I did), and still got it wrong.
I should have known the common sense answer was wrong! After all, we're talking economics.
Been a while since I've considered it formally...
Posted by: Jimm at Sep 2, 2005 7:23:21 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.
Posted by: Eric at Sep 2, 2005 7:24:40 PM
I love this blog, Tyler and Alex both, but I just think it's sad that the Marginal Revolution post that sets the blogosphere on fire is something so trite and iffy.
Posted by: Paul N at Sep 2, 2005 7:59:57 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.
Posted by: tomhynes at Sep 2, 2005 9:39:35 PM
Eric,
The "value" of going to see Clapton isn't stipulated in the original post. Therefore, the opportunity cost of seeing Clapton vs. Dylan can't be calculated. Only by stipulating that the "value" (i.e., benefit) of seeing Clapton and Dylan is the same, could I conclude that the opportunity cost of seeing Clapton is -$40. Why? Because by seeing Clapton I've derived the same benefit but saved $40. My point is that the original example doesn't provide all the data necessary to determine opportunity cost.
Now, suppose you value Dylan at $50 and Clapton at $0. If you choose to see Dylan instead of Clapton, your opportunity cost is not seeing Clapton (a $0 value) and instead seeing Dylan (at a cost of $40), for a net opportunity cost of -$10.
If, on the other hand, you opt to see Clapton for $0, you have foregone seeing Dylan (a $50 value to you) but you still have $40 in your pocket, for a net opportunity cost of $10. But that answer only holds if you value Clapton at $0 and Dylan at $50. The original post didn't stipulate a value of $0 for Clapton.
Alex asserts that he has "a hard time believing that this is possible but 78 percent of the economists gave the wrong answer!" I don't have a hard time believe that 78 percent of the economists gave the wrong answer because it seems that none of the economists was given a well-framed question to answer. They all had to supply their own assumptions about the value of seeing Clapton.
Posted by: Tom at Sep 2, 2005 10:06:01 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!
Posted by: Some Other Tom at Sep 2, 2005 10:10:47 PM
I don't understand why the answer isn't $0 since the Clapton tickets are free. People have said maybe the question is worded is tricky, ect, but as a laymen I don't understand what's tricky about it. Little help?
Posted by: Yet another Tom! at Sep 3, 2005 12:10:06 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.
Posted by: Ragout at Sep 3, 2005 1:04:33 AM
...seems the eternal-dogma of economic "Opportunity Cost" ain't so clear... neither is the
"elementary example" under discussion here.
Dollar 'cost' versus subjective 'value' are different concepts. {.."Accounting" cost vs "Opportunity" cost}
Alex likes the term "net benefit" ??
The subjective 'value' of best alternative forgone is the 'opportunity cost'.
If we somehow accept the 'premise' that a Dylan concert can be subjectively 'valued' at exactly $50 for this one evening .... then $50 is the 'value' of the best forgone alternative -- that is the "Opportunity Cost" here.
The "example" is bogus, since it does not matter what the first alternative is (...how 'bout an evening of Las Vegas gambling with a free million-dollar credit?) ---- the 'professor' has already defined in his example what the next-best-alternative is .... and its exact dollar 'value' {...so how'd he get the wrong answer ?)
Posted by: Talbot at Sep 3, 2005 5:00:57 AM
Many of them probably didn't read the question carefully.
That makes it more embarrassing.
Posted by: s9 at Sep 3, 2005 5:18:17 AM
I'm with ragout here. A common definition for opportunity cost is "the cost of a resource, measured by the value of the next-best, alternative use of that resource." It doesn't say NET value. The question is clearly stating that the value to you of seeing Dylan is $50, since you would be willing to pay up to that amount to see him.
Apparently there is an inconsistent defintion for opportunity cost, since I have seen the idea of NET brought into it in other definitions.
Posted by: smuggler at Sep 3, 2005 5:25:04 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.
Posted by: smuggler at Sep 3, 2005 5:54:01 AM
I answered $0. I still think I'm right. I've seen Dylan. He's good and all that, but I'd choose Clapton over him anyday.
Where the question states my perceived value of Dylan tickets, it leaves out my perceived value of Clapton tickets. Personally, I'd be willing to pay $60 to see Clapton. Does that mean I have an opportunity profit?
Posted by: Lockjaw the Ogre at Sep 3, 2005 6:34:40 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
Posted by: Don at Sep 3, 2005 7:06:40 AM
NO, NO, NO
The $10 is the consumer surplus you get from going to the dylan concert
-- the $50 in value you get less the $40 you paid -- not the opportunity costs.
Opportunity costs is used to evaluate foregone opportunities.
The opportunity costs are the alternative uses of the $40 the Dylan
concert cost. Since the other concert is free it is not an
alternative use of the $40. Now, if you were to ask the question in terms of the alternative use of your time, the Clapton concert could be included.
But since the question was about the money it looks like the discussion of the Clapton concert was just a red herring to confuse the people taking the test.
No wonder the answers were distributed equally. If you give someone the opportunity to select between four incorrect answers the odds are fairly high that the answers would be distributed equally or randomly.
Posted by: spencer at Sep 3, 2005 9:06:04 AM
Holy cow, I got it right and I had to guess what "opportunity cost" meant.
Posted by: Matthew McIrvin at Sep 3, 2005 10:48:07 AM
...Of course, that might be because the question was bad.
Posted by: Matthew McIrvin at Sep 3, 2005 10:49:43 AM
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.
Posted by: Bill Woolsey at Sep 3, 2005 12:10:09 PM
After reading these comments, I have determined that not all economists are idiots. Just the guys who wrote this survey and then made hay with the results.
Posted by: Auguste at Sep 3, 2005 1:09:54 PM
Thank God for your answer Spencer. Consumer surplus = 10. Opportunity cost = 40.
Posted by: decon at Sep 3, 2005 2:11:24 PM
No Spencer,
The answer is $10. As I mentioned above, it is the inadequate explanation in many texts "value of next-best alternative" that had many people understandably answering $50.
However, in no case can you argue that it is $40. Check out an econ text that has a good definition, like the one the authors used.
Posted by: smuggler at Sep 3, 2005 2:45:30 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
Posted by: MilongaMan at Sep 3, 2005 3:43:28 PM
The best way to think about about opportunity cost is
"the true cost of passing up the next best choice when making a decision."
When you give up seeing the Dylan concert, you've given up a benefit of $50, but you've saved $40. What you've truly given up by seeing Clapton is the difference or "foregone net benefit" of $10.
The opportunity cost of capital is the next best use for which that capital could have been used. If the next best use generated a profit of 2%, that's the opportunity cost, the net benefit foregone from the alternative use.
Posted by: smuggler at Sep 3, 2005 4:58:00 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.
Posted by: spencer at Sep 3, 2005 5:16:29 PM
Spencer,
The question was the opportunity cost of going to a Clapton concert, not the opportunity cost of spending $40 on something. There is no "alternative use of the $40" here; it's not relevant.
Think of it this way: the Clapton concert is your preferred alternative--this is given in the question. All that is relevant is what you give up with the next best alternative, which is also given. What else the $40 that you could have spent on Dylan could have been used for is irrelevant.
I agree that the question could have been worded better.
Posted by: smuggler at Sep 3, 2005 5:39:41 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.
Posted by: spencer at Sep 3, 2005 5:59:48 PM
Alex says it's "not a trick," but the way it's framed it is one of those "too much information" questions, since the value to you of the Clapton ticket is irrelevant and a choice between the two concerts is irrelevant.
The pure form of the question they are purporting to ask is: "What is your opportunity cost of NOT seeing Dylan if you would willingly pay $50 to see him and a ticket costs $40."
I realize the term "next best" has a meaning in econo-speak, but if they were really being precise in their language they would specify that you are "indifferent" between seeing Clapton or Dylan.
A better, or perhaps closer to real life way to phrase a question would be: "You have budgeted $50 to see a music concert Saturday night. Dylan tix cost $40 and Clapton tix cost $50. You are indifferent between Clapton and Dylan. What is your opportunity cost of choosing Clapton over Dylan?"
Posted by: Tom F at Sep 3, 2005 6:33:30 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.
Posted by: josh at Sep 3, 2005 6:41:33 PM
Okay, one more try:
Your preferred choice is Clapton--given in the question. Your next best alternative is the Dylan concert. This next best alternative costs $40, yielding a benefit of $50 (willingness to pay). Opportunity cost, or foregone net benefit, is $50-$40=$10. What your preferred alternative is, or how much it costs, is irrelevant in the question! The only info we need is ticket cost and benefit of the Dylan concert.
Josh, relative prices have no effect on the answer: if the Clapton concert cost $40, and was still defined as your preferred alternative, the answer would be the same.
Posted by: smuggler at Sep 3, 2005 7:09:51 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.
Posted by: Patrick R. Sullivan at Sep 3, 2005 8:59:36 PM
After reading with interest this blog post and subsequent comments, I've decided to offer you'all a free download of the entire Chapter 4 of my book. This chapter talks exclusively about the notion of opportunity cost. You can go to my blog Talkativeman.com and click under "My Book Chapter Excerpts" just below the book picture (left side of the screen).
There are other assorted blog entries pertaining to this book that you may find interesting.
Raj
Posted by: Talkativeman at Sep 3, 2005 10:34:01 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.
Posted by: Steve LaBonne at Sep 3, 2005 11:43:51 PM
The concept and logic of "opportunity cost" was developed by Friedrich Wieser. It's pretty clear that Mr. Tabarrok has no better understanding of opportunity costs than does your average "professional" economist -- or the folks who designed this question.
Opportunity costs are "subjective", the consist in ALL of what is given up in a choice, and they CANNOT BE MEASURED, not by dollars, not by anything. It is simply the incompetence of "modern" economic training which creates the intellectual illusion that such things can be demarked in dollars.
I can't believe there aren't economists at George Mason who are well aware of all this.
Posted by: prestopundit at Sep 4, 2005 1:53:53 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)
Posted by: Talkativeman at Sep 4, 2005 2:52:32 AM
I get it. I finally get it. The question isn't worded wrong. My definition was wrong.
Prestopundit - Obviously subjective costs can't be measured exactly by some dollar amount, but it is a success rather than a failure of modern economics to attempt to quantify something so abstract as far as it helps to understand the concept. The failure is when economists don't just see it as a conceptual aid.
Posted by: josh at Sep 4, 2005 1:25:15 PM
good for you, name usurper.
Posted by: joshg at Sep 4, 2005 2:00:36 PM
'Patrick, here's what you're confused about.'
Oh there's confusion in spades. But, the concept traditionally is that, BECAUSE you expend a resource one way, you forego expending it another way. And, pace Greg Ransom, the only resource being expended in the question is time. Not money. You can't be in two different places at the same time, so the opportunity cost of going to see Eric Clapton is not seeing Dylan.
But, to go the step farther of CALCULATING that to be $10 is silly. If you go to see Clapton you've got $40 left in your wallet that you wouldn't have if you went to see Dylan. Yet, Alex and the economists who wrote the question would have you incur a $10 cost to see Clapton.
Posted by: Patrick R. Sullivan at Sep 4, 2005 4:15:49 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 ??
Posted by: Rastus at Sep 4, 2005 5:11:31 PM
Hmm, I'm coming to this late but here's a few comments anyway:
1. It took me about a second to get the right answer. "Ten" I said outloud and quickly, though with a touch of anxiety (if 78% got it wrong why should I be better?), clicked on the rest of the post. Then I showed it to another econ student, then another and two more. They all looked at me like I was an idiot for even daring to bring this up. They all got the right answer in about a second as well. So I got a sample size of 5 to replicate this survey and I failed to replicate the result. In fact, even though reading the study makes it seem like everything's kosher on the surface the whole thing is just setting my alarm bells off and the bullshit detector is flashing red. There's no way that 78% of economists would get this wrong. There's gotta be something left out - I'd tend to go with the guy above who actually was part of the original survey seconds before a stressful job interview and said that the only thing he remembered was that taking the survey was the last thing he wanted to do. I also somewhat cynically suspect those who administered the survey - not the authors of the article but some hired students. Perhaps, meeting with a lot annoyed refusals some of them decided to fill in some questionnaires themselves and thought that if they filled it in 'at random' that would look legit. I shouldn't cast unfounded doubts, but like I said, there's something fishy going on. Any rate, if I was to referee this paper I'd tell the authors to replicate the survey in a few other contexts, with different people, different conditions and then come back...
So my overall conclusion is different. What this study shows is not that most economists are so mathematically overeducated that they don't know what 'opportunity cost' is, but rather that your average survey's gonna give you results that are pure crap, due to uncontrollable and often unnoted enviromental factors. Same thing, in my opinion, applies to some - though not all - of the so called 'experimental economics' field, at least the portion which relies on surveys.
2. The folks above who got it wrong for the most part are confused or plain ol' don't understand the concept. How much you value Eric Clapton is irrelevant - only that Bob is the next best thing. Whether or not you think Clapton 'rocks' and Dylan 'sucks' is too - the question tells you what your opinion is. And no, this is not 'consumer surplus'. Consumer surplus is the area between a demand function (in fact, a particular demand function) and a price, it is not the distance between a POINT ON a demand function and price. Most of the other objections are just over-thinking what is really a straight forward (to an economist) question. And I'm not sure it could be worded better. Someone somewhere will always find a way to confuse themselves. It's sort of like when asked how much is 2+2 starting out by defining the set of integers and the operation of addition.
3. The point about Friedrich Weiser by prestopundit is interesting but really, it's beyond the scope of this survey or the blog for that matter. The question wasn't about Friedrich Weiser would say the opp cost is, but what, in the way that the concept is taught nowdays it would be. I really don't think those who got it wrong were thinking of Weiser. And by the way, 'subjective' does not mean that it is not measurable, but rather that it is an evaluation carried out by an individual, not some outside value given by, say, the amount of labor that went into producing the good. If you wanted to be precise you could say something like 'suppose there's only three goods in the world, Eric Clapton concerts, Bob Dylan concerts and money, which can be considered as a numeraire' (which means there's some assumptions about the structure of preferances) but ... that would be like starting out by defining the set of integers and the operation of addition.
It's 4 (or 10$ as the case may be) dagnit, don't try to rewrite the entire field of economics, this isn't for the Nobel Prize.
Posted by: radek at Sep 4, 2005 9:31:12 PM
Was there an individual penalty for giving a wrong answer? No? Question answered.
Posted by: ogmb at Sep 6, 2005 3:38:38 AM
Argue this one with the Instructor...
The question states that the Dylan concert is your "NEXT-BEST alternative." This implies that given a choice you'd rather see Clapton, then Dylan, then somebody else. Looking at the problem from this point of view, the opportunity cost of going to the Clapton concert is $0. This doesn't excuse the majortiy of the Professional Economists, since it was only the 3rd most popular answer.
Anyone else make this assumption? According to the wording of the question, I don't see how you can assume that the person would rather go to the Dylan concert.
Posted by: Andy at Sep 6, 2005 2:25:35 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 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.
Posted by: DC at Sep 7, 2005 11:38:08 AM
My post above concentrated on verbal logic, but fell prey to bad math. (I also forgot which ticket was the free one.)
I shoulda said:
<<
If the Dylan ticket "had cost" $40, this $40 cost is sunk -- and the true opportunity cost of seeing Dylan rather than Clapton is $10. If the Dylan ticket "will cost" $40, these costs are not sunk, and the true opportunity cost of seeing Dylan rather than Clapton is $50.
>>
Posted by: DC at Sep 7, 2005 12:11:37 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.
Posted by: DC at Sep 7, 2005 4:47:29 PM
As I see it, the "correct" answer approved my Tabarrok is incorrect. It assumes that consumer surplus is the value to be achieved in any choice - and thus the value foregone in opportunity cost figurings. This is not the case. The value to be achieved is the thing itself. The consumer surplus is important for other issues, but not this one.
Posted by: Wirkman Virkkala at Sep 7, 2005 11:00:57 PM
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.
Posted by: Gavin Kenendy at Sep 9, 2005 3:36:59 AM
Got it right. I'll test my students this semester.
Posted by: MarcinGomulka at Sep 9, 2005 8:38:33 AM
"busy people perform poorly on meaningless tasks. If you want have 100% correct answers, buy them lunch if they get the answer correct."
That comment, above, pretty much hits the nail on the head.
Posted by: Stephen M (Ethesis) at Sep 20, 2005 10:47:37 AM
Wait just a dog gone moment!!!
The idea that opportunity cost is based on utility (expressed in $) of the good and netted with the owner's utility and the owner's maximum bid is just ludicrous.
Opportunity cost has nothing to do with the owner's/decision maker's valuation of the good in question. Opportunity cost is meant to identify the net income that would flow if an alternative choice was made. It is expressed as a stand alone figure not added or subtraced from the income associated with the chosen activity. Let me just one example.
You are going to work tonight for abc industires tonight and you are going to make $50 for working from 8 until 10. If you had as alternatives (same time, and travel time, travel cost, etc were not different) of working for Mike for $40 and Jill for $35, the opportunity cost (not working for Mike) is 40.
To address this question in a logical way, you have to start with the "chosen" path. The chosen path is to go to is to see Clapton, according the the question. The only reasonable application of the concept of opportunity cost would be to ask what is the opportunity cost of going to see Dylan. Going to see Dylan instead of Clapton costs you $40, and since opportunity costs are expressed as an alternative financial benefit to be gained, you opportunity cost is in fact -40.
Not a PHD, but a BS Econ.
Posted by: bg at Sep 20, 2005 4:05:53 PM
I think some people are misunderstanding the problem. The idea is that you can attend the Dylan concert, but for $10 cheaper than you would otherwise be willing to pay, ie for $40 instead of what you normally it - $50. Thus, by going to the Clapton concert you give up the $10 bargain on the Dylan tickets now, because its value terminates on the same day. Future Dylan tickets might cost $50.
It is interesting to note that an Austrian Economist would correctly have answered $0. Because the primary choice is all that counts. Opportunity cost is a meaningless illusion as people select their best course of action. Besides, any value one attributes to a Dylan concert may change after seeing Clapton. Dylan may even charge less in the future.
I bet Milton Friedman said $0 (glad not to pay amusement tax), Lester Thurow said $10 (lamenting he didn't pay the $50 so he could pay more tax).
Posted by: The Legal Thespian at Sep 20, 2005 6:38:24 PM
Suppose I would pay 100 to see Clapton on any given night. If I go see Dylan instead, my opportunity cost is 90. I've "saved" 10 bucks on the Dylan concert, but I've foregone 100 bucks in value to do so. If I see Clapton, I've lost 10 bucks, but gained 100 bucks in value, so I'm not too worried about this. My opp. cost is 10 bucks, as per the original question. Suppose the same shirt is on sale at two different stores. I go to the store where the shirt costs less. I still have an opportunity cost of not taking advantage of the less advantageous sale at the other store, but I don't give a damn, because I got a better deal. I see a five dollar bill and a 20 dollar bill on the ground. I can only pick up one. I choose the 20, so my opportunity cost is 5, but I don't give a damn, cause I've made 20 bucks. Am I getting this right?
Posted by: JM at Sep 21, 2005 12:11:01 PM
Perhaps it would be easier if the question didn't have the distractor of Clapton. Let's rephrase it.
Bob Dylan is playing at a concert and it will cost you $40 to see the concert which you would pay $50 to see. What is the opportunity cost of sitting at home and watching the test card on TV?
The answer presumably is $10 since you have foregone the opportunity to have $50 worth of goods for a cost of $40.
Let's take another example: you can buy a used car for $4,000 and sell it tomorrow for $5,000. What is the opportunity cost of leaving your money in a non-interest bearing account?
Frankly though, neither question seems to have any relevance to the real world, and I wonder why we bring up the question of opportunity cost in these cases.
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