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Opportunity Cost by ERIC NIELSEN JARGONALERT Opportunity Cost BY ERIC NIELSEN here is an old saying, “You can’t have your cake and eat would be better off working the extra day and a half, and then it too.” Although this bit of folk wisdom may seem flying. For a student or someone else with little earning power, T corny, it carries with it significant economic wisdom. it still might be cheaper to spend the extra time and drive. So It gets at the heart of one of the most important concepts in opportunity cost decisions involve many more factors than economics: opportunity cost. The opportunity cost of some- simply the dollar costs associated with various alternatives. thing is simply what you must give up in order to get it. Opportunity cost also plays an important role in what econ- Resources are always limited, so not all wants can be omists call the labor-leisure decision. Possibly the most basic satisfied. When you take a course of action, you use resources decision you can make is how to divide your time between work that cannot be applied to other projects. The opportunity cost and play. All else being equal, most people prefer leisure to is the value of those foregone opportunities. For example, if labor. At the same time, the greater wealth which comes from you decide to spend your money on a new bicycle, you cannot working allows us to consume things we like, and gives us also spend it on a new com- greater freedom as to how puter. Or if you spend an we spend our leisure hour watching television, hours. You must take you cannot also spend into account the compet- that time reading a book. ing desires to have some Opportunity cost is money to spend versus in many ways the most the pleasure of relaxation; fundamental idea in eco- the opportunity cost of nomics. Economics at its taking a day off is the core is the study of how amount that you could decisions are made about have earned if you had the allocation of finite worked. As another old resources in the real saying goes, “Time is world. If resources were money.” not limited, there would Governments must be no reason to forego also consider the oppor- any desired activity and tunity costs of their all projects could be actions. For instance, it undertaken. Every action would seem that a natural has an opportunity cost, way to increase revenues so it is important to try to would be to raise marginal understand the full extent of these costs. tax rates — that is, raise the rate at which each additional dol- Before the emergence of money, people traded goods lar of personal income is taxed. Although it would appear that a directly, which made opportunity-cost relationships more higher tax rate on a given income stream would yield propor- obvious. One of the main functions of money, then, is to tionally higher total tax revenue for the government, that is not assign a unit of account to the relative costs of various items. necessarily the case. By raising marginal rates, the government Rather than having countless hard-to-fulfill barter relation- has altered the labor-leisure calculation; it is now cheaper for ships — such “as one car costs 1,500 pizzas” — you need only a worker to forego an extra unit of labor in favor of leisure. The have their prices in dollars. The dollar price of various items tax increase, then, likely will have the effect of reducing how reflects their opportunity costs. much people work — which will tend to dampen or, in extreme To make an economic decision, you must fully consider the cases, possibly even reverse the expected effect of the rate hike. opportunity costs associated with various options. For exam- In short, many choices have consequences that are not ple, say you are confronted with the choice of flying or driving immediately obvious. But to fully evaluate any decision — to visit a friend in Chicago. A plane ticket costs $300, while gas whether it is made by an individual or by the government for your car will only be $125. Given those figures, it’s more eco- — people must consider both “the seen and the unseen,” as nomical to drive, right? Actually, the answer is not so clear. For the 19th century French economist Frederic Bastiat put it. instance, if it takes two days to drive to Chicago and back but Opportunity costs are often unseen, yet they remain real ILLUSTRATION BY TIMOTHY COOK only four hours to fly, a person earning a reasonably good salary and important. RF 6 Region Focus • Fall 2004.
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