Opportunity Costs - Their Use and Misuse

Opportunity cost is one of the most important concepts in microeconomics. A solid understanding of opportunity costs both allows us to make better decisions and to better understand the decisions made by others. However, the concept is often used erroneously, as it was earlier this week by an Ontario politician.

A straight-forward definition of opportunity cost is found at About.com:

The opportunity cost of any action is simply the next best alternative to that action - or put more simply, "What you would have done if you didn't make the choice that you did".

There are two key points in this definition:

1. The alternative has to be feasible, that is it was an available option that the person making the choice had.



2. There has to be a real tradeoff. It is not possible to have A and B at the same time. By choosing A we give up the opportunity to obtain B.

The first point is often violated in erroneous opportunity costs when relationships end. I am sure we have all seen this at some point in our lives. A couple breaks up and one (or both) of the ex's decides to start dressing better, loses 20-30 lbs, gets into shape, etc. in order to show their former partner "what they're missing". It's not at all a valid opportunity cost argument, because the person wouldn't have taken all those steps had they still been in the relationship. The opportunity cost of being out of the relationship is not being in a relationship with the out-of-shape, sweatpant wearing person - not with the well dressed physically fit person they later became.

Before I discuss the second point, I need to add the following disclaimer. I am not trying to make a partisan point here - all political parties, at some time or another have used some form of this argument. This time it was the Ontario Progressive Conservatives, but next time it could be the Ontario NDP, Greens or Liberals.

A few days ago I opened up my hometown London Free Press and found the following article: Province likes fast food calorie count idea:

Ontario could move ahead with forcing restaurants to post the calorie counts of their meals, Health Promotion Minister Margarett Best said Wednesday.

An interesting idea that I was looking forward to hearing arguments both for and against. The bottom of the article PC leader Tim Hudak gave his reasons for being opposed to the plan:

“There’s a lot of red tape out there and what I’m hearing from families is that life’s getting more expensive,” he said. “What their top priority is is lowering the taxes their paying.

“I don’t hear them worrying so much about what the menus say,” Hudak said. “I’m hearing about how much more prices are increasing.”

It appears that Hudak is making an opportunity cost argument here (though there may be alternate intepretations) - that the Liberal government should introduce a bill lowering taxes, not one introducing calorie counts on the menu. But why can't the Liberals do both? At any one given time the legislature is juggling about two dozen bills. There is absolutely no reason this session of the legislature cannot debate both issues. Where is the opportunity cost here? I don't see it.

There are all kinds of opportunity costs when it comes to public policy. I just wish politicians of all parties had a better understanding of the concept. It would lead to improved public policy and a more informed electorate.

Comments

[Greg Ransom]

It looks to me like your PC leader there simply understands politics better than you.

I don't see the fallacy.

[Left Outside]

"The first point is often violated in erroneous opportunity costs when relationships end. I am sure we have all seen this at some point in our lives."

Just before this sentence I went to get a drink and, guess what, thought about an ex. Its like you're psychic.

It does sound like an opportunity cost argument. Not a particularly good one either.

I believe here in the UK restaurants (at least of a certain size) have to provide information like that, but it is very rarely displayed, and even less rarely looked at. But it is there if needed.

[Greg Ransom]

Paul Heyne, Pete Boettke et als use the opportunity cost notion to teach economics in their _The Economic Way of Thinking_.

Economics students would get something out of their time spent taking econ if more economics professors did the same -- most undergraduates remember hardly a thing from there economics classes, studies show, and few if any pick up "the economic way of thinking".

[GA]

The implication is that 'priorities' - the things one can reasonably expect to get to and complete - are a weak form of opportunity cost. It's not "I can turn left at this T-junction or turn right" (no political pun intended), but "I can only expect to get X number of initiatives through a legislative session. I need to choose between them."

And it's a classic political accusation: "your priorities are wrong, and you're wasting time/capacity on Y when voters care about Z." Not a great argument, but not strictly speaking wrong.

[Min]

About.com: "The opportunity cost of any action is simply the next best alternative to that action - or put more simply, "What you would have done if you didn't make the choice that you did".

It seems to me that this is pretty sloppy language. Does this formulation get the concept right?

The opportunity cost of any action is the payoff from taking whatever other course of action you would take in the situation if you did not take that action.

That formulation does not assume that you would have taken the next best alternative. E. g., if the relationship does not end, you won't make yourself over, even if that is the next best alternative to ending the relationship and making yourself over.

Mike Moffat: "It appears that Hudak is making an opportunity cost argument here (though there may be alternate intepretations) - that the Liberal government should introduce a bill lowering taxes, not one introducing calorie counts on the menu."

He is giving reasons to oppose the plan, not reasons not to introduce the legislation. (Although, OC, he would prefer that legislation he does not like not be introduced. ;)) There are the suggestions that the regulation would raise the cost of meals for customers and inconvenience the restauranteurs (red tape), both of which would be costs by comparison with not implementing the plan.

[Mike Moffatt]

Left Outside: I've been thinking about this 'ex' issue a lot lately, since I seem to be at an age (mid 30's) where I know more people getting divorced than married. It's shocking how many people (both men and women) after getting married go completely to seed intellectually, emotionally and physically.

Greg Ransom: Most undergraduates didn't have me as their lecturer.

GA: "I can only expect to get X number of initiatives through a legislative session. I need to choose between them."

Except 'X' is non-constant. It's not as if a government can get through exactly 20 initiatives and if it wants to add one more it has to drop one of the 20. Furthermore in a majority government situation, it can always combine initiatives. Former Premier Mike Harris was famous for this - his Bill 26 (the 'Omnibus bill') altered ~40 different laws in one go.

Min: "He is giving reasons to oppose the plan, not reasons not to introduce the legislation."

True, he does in the section RE: red tape. That is a coherent argument. The part about 'taxes being top priority', as an opportunity cost argument - not so much.

[Alex]

The first point is often violated in erroneous opportunity costs when relationships end. I am sure we have all seen this at some point in our lives. A couple breaks up and one (or both) of the ex's decides to start dressing better, loses 20-30 lbs, gets into shape, etc. in order to show their former partner "what they're missing". It's not at all a valid opportunity cost argument, because the person wouldn't have taken all those steps had they still been in the relationship. The opportunity cost of being out of the relationship is not being in a relationship with the out-of-shape, sweatpant wearing person - not with the well dressed physically fit person they later became.

This is interesting, because we can construct an economic version of this. As before, girl dumps guy. This time because he's poor and doesn't look after her. So guy goes out, works really hard at whatever, and makes loadsa money to show her "what she's missing". And as before, this isn't a valid opportunity cost argument. But is something. And things like it do happen. And it has real economic consequences (he worked harder because she dumped him). Have these types of incentives been looked at by economists?

[Alex]

Oh yeah, one further point I meant to make. These "what they're missing" scenarios do sometimes work. It seems this is further evidence against homo economicus. - people make decisions based on fallacious opportunity cost arguments.

[Just visiting from Macleans]

Mike, you are engaging in a straw man argument (although you acknowledge there may be alternate interpretations).

Hudak never used the term "opportunity cost" in the article you linked to. He was simply stating that voter's priorities lie elsewhere. I agree with GA's analysis. You labelled it as an "opportunity cost" argument, then discredited it because it was not a true opportunity cost argument.

Personally, I believe Hudak is engaging in the slippery slope argument. Once you force restaurants to start listing the calorie content of their meals, it encourages a new discipline and level of bureaucracy - fast food economics. Listing of calories/$. Marginal value of a date square. Biggest bangers for the buck. Opportunity cost of a baked potato vs poutine. etc. etc.

[Mike Moffatt]

"Hudak never used the term "opportunity cost" in the article you linked to. He was simply stating that voter's priorities lie elsewhere."

Which is essentially an opportunity cost argument. If there is no opportunity cost, then why would it matter if voter's priorities lie elsewhere? It's a non-sequitur then - he might as well say, "We shouldn't enact this policy because Tampa is in 1st in the AL East and I wear a size-11 shoe".

"These "what they're missing" scenarios do sometimes work. It seems this is further evidence against homo economicus. - people make decisions based on fallacious opportunity cost arguments."

Absolutely. I'm actually writing a book on behavioural economics that examines this. Unfortunately the rate I'm going it won't be done until about 2047.

[Alex]

I have the opposite problem. At the rate I'm going I won't be done reading the books I currently own by 2047.

"I believe Hudak is engaging in the slippery slope argument"

Now who's engaging in a straw man argument?

Hudak complained about red tape. He didn't complain about where that red tape might lead to.

A slippery slope argument (which is also fallacious by the way) would be something like this: "Clement Attlee's policies will take us on the Road to Serfdom".

[Phil Koop]

Of course it's an opportunity cost argument - to the extent that it's an "argument" at all. I am amazed at the stubborn resistance to this concept displayed in the comments.

But your caveat is the main point here: politicians of every party, as well as every special interest group under the sun, use this maneuver routinely. The script runs: someone else holds a press conference; frequently, as in this case, in order to garner positive publicity. You don't have the drawing power to hold a similar press conference of your own on your own agenda, so you try to high-jack the machinery of your opponent with the "let's focus on the real issue" ploy. Journalists cooperate because it plays well to their "even-handed" he-says she-says formula.

[Alex]

Of course it's an opportunity cost argument - to the extent that it's an "argument" at all. I am amazed at the stubborn resistance to this concept displayed in the comments.

Would you care to expand on your point? I don't find assertions to be persuasive.

[Just visiting from Macleans]

Alex, it was a joke. The link I provided on slippery slope, in the first line, should have given you some indication:

In debate or rhetoric, a slippery slope (sometimes misstated as thin edge of the wedge, or the camel's nose) is a classical informal fallacy.

Mike - do they not still teach time management at Ivey - creating a priority list A,B,C? A you do absolutely first - critical. B, second level of priority. C - you drop, stick in your bottom drawer, never to see the light of day again. Exactly the same thing here. McGuinty's A is Hudak's C.

(btw, as a kid I used to deliver the Freeps)

[Mike Moffatt]

"Mike - do they not still teach time management at Ivey - creating a priority list A,B,C? A you do absolutely first - critical. B, second level of priority. C - you drop, stick in your bottom drawer, never to see the light of day again."

This suggests the following:

1. Hudak thinks this is worth doing, but only after a number of other things are completed first. Which doesn't seem to be the case, as Hudak later implies that the idea is a bad one. Which is it?

2. That the McGuinty government is running at full efficiency and can't possibly add one more thing to their agenda.

"Of course it's an opportunity cost argument - to the extent that it's an "argument" at all. I am amazed at the stubborn resistance to this concept displayed in the comments."

That's internet for you - if you post an article stating 2 + 2 = 4, you'll get a dozen people disagreeing with you. I am almost didn't post the piece because I thought it was too obvious and all I'd get were responses of the "That's nice, but you don't understand politics" variety.

[Just visiting from Macleans]

Which doesn't seem to be the case, as Hudak later implies that the idea is a bad one.

By my classifying it as Hudak's "C" priority, the answer should be self evident - "C - you drop, stick in your bottom drawer, never to see the light of day again."

That the McGuinty government is running at full efficiency and can't possibly add one more thing to their agenda.

You have a much more idealistic view of politics than I do. McGuinty is running a what? $25 billion deficit. This is a channel changer, a distraction, a feel good effort. It's politics, not theoretical economics.

[Shiny Happy Conservative]

The opportunity cost of climate change bunk is that nobody is talking about deforestation, acid rain, clean water, smog, or any other legit environmental cause, and that is a very bad thing. Elizabeth May and the Green Party have all but given up on the environment choosing instead to focus exclusively on the climate change scam. At the very least, AGW disciples need to acknowledge the opportunity cost here.

If I were a corporate polluter or clearcutter, AGW hysteria is the best thing to ever happen, as it allows me to do my thing while those ostensibly charged with caring about the environment are distracted by other matters.

There have been a number of very major spills in the Ottawa River in recent years, including radioactive spills from Chalk River, and hardly anybody noticed or cared. The very water pumped into May's (at the time) Rockliffe mansion is freaking radioactive and she flat out ignored it. Not cool man, not cool.