Freeman

ARTICLE

The Economic Way of Thinking, Part 6

All of Our Choices Have Opportunity Costs

MARCH 01, 1994 by RONALD NASH

Dr. Nash is Professor of Philosophy and Theology at Reformed Theological Seminary in Orlando, Florida. He is the author or editor of 25 books including Poverty and Wealth, Great Divides, and Social Justice and the Christian Church.

Last month, I pointed out the value of approaching economics as a way of thinking, not as a set of doctrines and theories. I also explained how there is nothing terribly complicated about the economic way of thinking, once certain fundamental principles are understood. While much of this material turns out to be a matter of common sense, people who are unaware of these principles will have trouble understanding why some things in life are true.

In Part Five, I dealt with the first of these principles of the economic way of thinking: Incentives matter! When you give people incentives to do A rather than B, the number of people who choose A rather than B will increase, all other things being equal.

Every Choice Involves Some Cost

This essay will deal with the obvious fact that every choice carries a cost. Because human beings live in a world marked by scarcity, nothing is free. Every economic good has a price in the sense that before anyone can obtain it, he must sacrifice something else. It is impossible to get A (some economic good) without giving up B (some other economic good).

The economic principle in view here is often expressed in such old sayings as: “You can’t have your cake and eat it too” and “There is no such thing as a free lunch.” The unavoidable fact of scarcity forces us to make choices in which we sacrifice some things in order to obtain others.

Ranking Our Options

Economics studies the ways in which people attempt to satisfy their wants with the resources at their disposal. It is concerned with how people choose to bridge the gap between what they have and what they want. Because our resources are never sufficient to satisfy all of our wants, we have to make choices about how to use our resources so as to supply the wants that we judge to be most important.

As human beings seek ways to get the most out of their limited resources, they are forced to rank their available alternatives. This ranking will reflect the individual’s own personal order of values. Everyone has a scale of values by which his needs, wants, and goals are ranked in order of the importance and urgency he attaches to them. Even though we may be unconscious of the process, we all engage in a constant ranking of the relative value to us of things we want but do not possess and of things we possess but might be willing to trade for something else.

Several things follow from the fact that people place different values on things. For one thing, if person A values x (some economic good) more highly than person B does, A will be willing to sacrifice more in order to secure an additional unit of x. Moreover, since person B values x less than A does, B may be willing to trade some quantity of x to A in exchange for something else that B desires more. It would be difficult for market exchanges to occur in a community where everyone placed precisely the same value on everything.

Not only do value scales differ from person to person, the value scales of individual persons are constantly changing. As people’s interests, wants, and information change, their preferences change. The things that a person puts forth the greatest effort to secure at any given moment are those that rank highest on his personal scale of preferences at that moment and in those circumstances.

Obviously, then, economic value is subjective. The reason people choose one economic good over another is not grounded on any objective value inherent in the good itself. Their choices reflect the value they impute to the good at the moment they make the choices.

Cost Versus Money Cost

Economic choices are geared towards maximizing benefits and minimizing costs. It should be clear that the word cost has more in view than the mere outlay of money. The more someone believes he is likely to benefit from an action, the more likely he is to act in that way. Greater benefits make a choice more attractive; higher costs make it less attractive and make it less likely that someone will select the most costly option.

This analysis of economic choice entails neither materialism nor selfishness. It does not assume that human beings seek only money or material goods or their own welfare. There are times when the welfare of others ranks higher in our scale of values than our own well-being. There are occasions when we willingly incur significant money costs because the possibility of giving up something other than the money in question is viewed as too high a cost.

Some people want certain goods for the express purpose of being able to use them for the well- being of others. Some regard many things as more important than paper and metal money. Some people give a higher priority to serving others than to serving themselves. Their economic choices will reflect these priorities.

Opportunity Cost

In every economic choice, something is gained; but something else must be sacrificed. What economists call opportunity cost is the subjective value of the highest ranked option or opportunity that someone forgoes in order to obtain some good. Most people think of the cost of some good solely in terms of the money they must surrender in order to acquire it. Such thinking confuses money price with cost.

If I had not used scarce resources to acquire A, I could have used them in other ways. Suppose, in this case, that of all the available options, one alternative (call it B) is my first preference to A. But when I decide to acquire A, I forgo the opportunity to acquire B. My sacrifice of B then is the opportunity cost of my buying A. Since people’s value scales differ, it follows that different people who acquire A will have varying opportunity costs. For one person, the opportunity cost of buying a large screen television set might be a vacation in Monument Valley, Utah. For another person, it might be a large donation to starving children in Somalia. It is important therefore to recognize that the cost of anything involves more than money cost; it is actually the cost of forgone opportunities.

An Example

Several months ago, I accepted an invitation to speak to a civic organization in a large city. I agreed to speak because the affair was an opportunity to introduce a number of influential people to a subject I care about, family choice in education. On the day I accepted the invitation, there was nothing else on my schedule, so my opportunity cost amounted to several hours of lost time, time that I probably would have spent completing my new book.

But a few days before my date with the civic organization, a friend called to invite me to play golf at a well-known country club. Unfortunately, the golf date conflicted with my scheduled meeting with the Kiwanians. I was faced with an either/or situation: either play golf at a very special course or speak to the Orlando Kiwanis Club. At the risk of offending some Kiwanians, I have to admit that I really did prefer the golf match. Nonetheless, I told my golfing friend that I had another commitment.

Some might think the example conflicts with my earlier observations about how we always choose the highest ranked alternative in our scale of values. It seems clear that I ranked that round of golf higher than speaking to the Kiwanis Club. Does my decision not show that the option I selected was not the thing I valued most at the time? The reason it does not rests on the fact that there was something else that ranked higher in my scale of values that day than either the Kiwanis meeting or the golf match, namely the importance of keeping a promise and the opportunity to represent the cause of school choice before an important audience.

What did it cost me to speak at that Kiwanis meeting? Originally, I thought my opportunity cost would only be a few lost hours that I could have spent working on a book. That was no big deal. But now, it was the loss of a coveted round of golf. This cost was serious enough to elicit an “Ouch”! But obviously I also thought that the opportunity cost of breaking a promise and abandoning an opportunity to representan important cause would be even more severe.

There is nothing unusual about my decision. Every reader of this essay has done similar things many times in his or her life. In my case, my understanding of the notion of opportunity cost aided my understanding of myself and the reasons for my final decision. It is easy to see, however, how someone not familiar with the principle of opportunity cost—the part of the economic way of thinking that is the topic of this article—might have difficulty sorting things out.

Introducing Children to the Notion of Cost

Children and, for that matter, many teenagers can be helped through an understanding of the concept of opportunity cost. Some parents mistakenly give in to every request or demand of their children. When parents do this, they incur opportunity costs for themselves; they make sacrifices. Why shouldn’t children learn that choices always involve costs? I recognize that this can be overdone with small children. But as children mature, understanding how scarcity requires choices and how choices involve costs may help them mature more quickly and become more responsible.

Many people in their teens and twenties demonstrate a total lack of acquaintance with this subject. It is natural to wonder how many of the foolish and immature things young people do result from their inability to recognize the true costs of their actions. It also seems highly likely that one reason many adults behave in equally foolish ways is that they also have not learned to recognize the true costs of their decisions.

Even though I spent close to thirty years teaching in a large state university, I am now a professor in one of the ten largest theological seminaries in the world. I introduce the students in my ethics classes to the principles of the economic way of thinking. To the future ministers in my classes, I strongly suggest that they can find some valuable preaching material in the notion of opportunity cost. Jesus once told about a wealthy farmer who cared only for the accumulation of more wealth and who failed to realize that the opportunity cost for his pattern of living was the loss of his soul. It would be an interesting experiment for some to go through the Bible and identify the serious consequences that befell certain well-known individuals in Scripture who failed to recognize the true costs of their bad decisions.

But this essay is not a sermon. It is simply an introduction to an extremely important principle of the economic way of thinking. Realizing that all our choices entail costs that often go unrecognized might prove to be one of the important lessons we learn in life. []

A Lesson in Liberty

Just a few years ago our family read the Little House on the Prairie series by Laura Ingalls Wilder. Though living outside of town on a claim, Laura and her family were wakened one Fourth of July in the pre-dawn darkness by gunpowder exploding under the town blacksmith’s anvil. Ma wasn’t interested in the main attraction of the day–horse races–and baby Grace was too young, so Pa, Laura, and Carrie made the trip to town for the simple celebration. After a quick and light lunch the festivities began with a speech recalling the struggle to obtain their liberty and a public reading of the Declaration of Independence. (Laura and Carrie knew it by heart–quite a commentary on old and new educational systems.) But after the reading an eerie silence fell over the crowd, almost a holy hush, which was broken courageously and spontaneously by Pa’s singing “My country, ‘tis of thee, sweet land of liberty . . . .” Everyone joined in, recognizing the appropriateness of the song for the occasion. As the song ended the crowd scattered away, but the last lines of the song, combined with the prior reading of the Declaration, gave Laura a life-changing lesson in what it means to be free: “Long may our land be bright, with freedom’s holy light, protect us by Thy might, Great God, our King.”

Laura realized God was America’s king and that Americans don’t obey an earthly king, but are free. But since no king controlled her father, he had to control himself. She realized as she grew older her parents wouldn’t be controlling her any longer either, and that she would have to live a moral life on her own. She had to be self-governed, and keep God’s law, the only thing that she felt gave her the right to be free.

—Marty Mattocks

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March 1994

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