Learning a concept: Opportunity Cost

I'm well.

How's school going?

Going very well, enjoying it as usual.

Python still going well?

Yes, it is.

Very good. Well, your dad had said that you were interested in economics or were asking questions about economics. Is that true?

Yes, it is.

Tell me about why you're interested in economics and what part of economics you're interested in.

Um, well, I've just— I've noticed different parts of economics as I'm getting older. Um, as for what part I'm interested in, I don't really have a certain subject or part as I'm still going into that. Um, I was just asking questions as I thought of them.

Do you remember any of the questions you were asking?

Um, I don't off the top of my head. I don't know when this was.

Okay, no problem. I've got something that may seem, um, a little bit abstract, but I think it's good to start with concepts. Often I think of learning about something as starting with the concepts in that discipline, and then once you have a bunch of concepts, then you can build on top of the concepts you have. Does that make sense?

Yes, it does.

So a concept in economics, and I often— so some things are kind of, kind of obvious. So for instance, you can say there are prices, you know what a price is, right? Like a price of candy or gasoline or whatever. Prices, we get that. You know something about costs, that if you're trying to buy something, it will cost you whatever the price is, right?

Yes.

So we're going to go to a slightly less obvious kind of concept, which is the idea of opportunity cost. Do you want to try reading this?

Sure. When economists refer to the opportunity cost of a resource, they mean the value of the next highest valued alternative use of that resource. If example, or if for example, you spend time and money going to a movie, you cannot spend that time at home reading a book, and you cannot spend that money on something else. If your next best alternative to seeing the movie is reading the book, then the opportunity cost of seeing the movie is the money spent plus the pleasure you forego by not reading the book.

So does that make sense?

It does.

So how would you explain opportunity cost? If somebody said, hey, what's opportunity cost? What would you say?

Um, I'd probably give an example like this. Um, I'd probably say something like, if you wanted I don't know, a Twix or a Snickers, um, but, and you enjoy both, or let's just say you're gonna have a Twix, but then you see that the Snickers is cheaper or it has a higher value, um, then you might go and get the Snickers because you think it has a higher value. That may not be the best example, but I, I do believe I have learned something like this before.

Okay, well, let's, let's go into the example that he uses. This is an economist named David Henderson. He says, he gives the example of going to a movie. So if you were going to go to the movie tonight, do you know about how much it would cost to go to the movie?

I don't. I don't go there often.

Yeah, I don't either. I haven't been to a movie in a theater in years. But just because everything gets more expensive, Maybe it's, say, $20. It could be that much. It used to be cheaper, but maybe it's $20. So if the tickets to get into the movie are $20, is that the full cost of going to the movie tonight?

Most likely not because, I mean, just if you don't add in the price of snacks that you might buy, most people buy popcorn or some kind of candy.

Okay. So maybe you might spend another $10 on goodies. So $20 ticket plus $10 on goodies is $30 the whole cost of going to the movie tonight?

Well, there are— there probably are other factors, as in you might, I don't know, find something else that you might want to buy, or maybe I don't know, you have to go get something else.

Okay. So opportunity cost is a little bit different. Let's read it again. I'm going to read it again and then we'll see if we can make sense of this. So sometimes it's easier when you're reading stuff, especially if it's a little hard, it's hard to process what it's saying too. So I'll read it and we'll see if we get a little bit more clearly. When economists refer to the, quote, opportunity cost, end quote, of resource, They mean the value of the next highest valued alternative use of that resource. Let's pause there. Do you have any idea what he means by the value of the next highest valued alternative use of that resource?

Well, let's— I mean, if you have something else that has a higher value than the thing that you're doing.

Okay. That sounds generally— that makes a lot of sense. Let's go on and read his example and see if his example is consistent with what you're saying. If, for example, you spend time and money going to a movie, you cannot spend that time at home reading a book, and you cannot spend the money on something else. Does that make sense?

Sort of. I'm getting confused. If he means you should spend the time reading or you shouldn't, or— yeah, I don't know.

That's a really great question. That's a really great question. So suppose— let's do a different example and see if a different example makes sense. Suppose— do you ever do any work where you can get paid?

Um, not yet, no.

Okay.

Have you—

have you and your family talked about you at some point, um, making money doing chores or doing something like that?

Yes.

What kind of things might you get paid for at some point?

Uh, chores, um, helping other people with their things, um, summer jobs, just going to, I don't know, a park and selling something.

Okay. What kind of summer jobs are you thinking of?

Well, I do know someone. I think her company is called Pareto, if you've heard of them. I met her last year. And I'm going to write a proposal and it's going to be Awesome. I'm going to see what she says.

What would you do for her?

Um, well, I would mostly— and this doesn't have to be for money, I just want to go and learn. Um, I would want to sit in their meetings and just learn and then take notes, give it to them. Just something that they can get out of being there.

Okay, excellent. I think that sounds like a marvelous idea. But I just wanted to use the example of you making money as an example to get a bit more clarity on opportunity cost. So suppose you could either go to one of her meetings— since today's Sunday, we'll call it Monday because it's workday— you could go to one of her meetings tomorrow and make $30, or you could go to a movie and spend $20 on a ticket and $10 on goodies. So you could either make $30 or spend $30 in the same, say, couple of hours. How can you figure out what the cost of going to the movie is then?

The cost as the opportunity cost or the actual legitimate cost?

Well, let's do both. So what would the opportunity cost be?

Well, I would probably go with making $30. Because I think that's always better in most cases. Plus, if you make $30 and then you go to the movies, you— and if you just buy the goodies with $10, then you end up with the same amount you had before. Um, so the opportunity cost for going to the movies would be you'd lose and not, um, get, achieve. And then, uh, going to work And then earning is, in my opinion, better than going to the movies and sitting there watching a movie for a few hours and losing a bunch of money.

So how would you describe the total? Suppose you have friends and your friends like, please, please, please, please, please, please, Alana, go to the movie. And you're like, okay, I'll call up my employer and say I'm going to skip work today and I'll go to the movie. How much would you say going to the movie because your friends twisted your arm actually costs you?

Costs actually, or opportunity cost?

Opportunity cost.

Um, well, you are with your friends, and that might make it better, or your opportunity cost or value better. Um, that's probably the first thing I would think of, because if you were going alone, and I mean, I probably wouldn't go to the movies alone.

So going to the movies with friends makes going to the movies more valuable?

Um, I think, I mean, I think so. If I'm going out to the movies with my friends, it's always enjoyable, especially my friends. I really love them.

Okay, so can we, can we figure out the dollar cost and then say we can say the benefit? So the benefit of going to the movie is bigger when your friends are going because really it's about hanging out with your friends than actually seeing the movie anyway. So you get a bigger benefit, but what is the cost if you skip work to do so? What is the total dollar cost?

Well, then you lose making it, you lose the opportunity of making another $30 $30, uh, so you lose $30 in a sense because you don't gain it.

So you lose $30. What about the $30 you actually spend on tickets and, um, goodies?

Well, then you're losing another $30, especially if you're just paying for your own things. If you're paying for everybody else's, then that's going to be a higher cost. Or yeah, you're going to have to spend more.

Yeah, let's just to keep it simple. So that's a really interesting case when we're paying for everybody else. But just to keep it simple for— so you lose $30 because you didn't go to work and you spend $30 on your own goodies. Would you say if you lose $30 and spend $30, in a sense, the cost of going to the movies is $60?

Um, well, the cost of going to the movies, you're only really losing, or actually losing 30 because you didn't actually get the money from work. All right, yeah, if you didn't go to work and then you just go to the movies and then you lose just 30 in a sense. And the reason why I said you also lose a 30 from work is just because you didn't go and earn that money, that extra money. Um, but I mean, that the actual money that you're losing is from the movie.

Okay, so you're not counting the $30,000 that you could have made from going to work?

Uh, in this sense, I probably wouldn't because I don't actually have that money.

Okay, let's look at a slightly different case. Suppose you call your employer up and say, hey, my friends really want to go to the movie. So I'm going to go ahead and go and miss work today. And suppose your employer responds, Alana, I really, really need you at work today. How about I pay you $300 if you come and do the work instead of going to the movie? First, which would you do in that case?

Uh, I mean, I'd probably go to work. I mean, it's $300. There will always be another day for a movie, for, um, watching a movie in the movie theater with your friends. Um, and you're— instead of $30, you're getting $300, which I think is a big change.

So that makes sense. Now suppose a little different hypothetical. Now suppose, um, your friend's mom has already dropped you off at the movie theater with your friends, and her cell phone died, and she's not there. And so this is when you hear from your employer that it would have been $300, but you can't get to work on time because, you know, you don't have transportation. And so even though you would have preferred to go to work, you're going to the movie. Now, how much would going to the movie cost you?

Well, that depends if your work is online or physical, because if it's online, then you could— and you're good at it, you could probably just do some of it off of your phone. You may get— you may not get the full $300, but you'll get something. Okay, um, but if your work was in an office, physical, and you were already at the movie theater, then you're all— you're losing $300 for the opportunity to get $300, and you're also losing the $30 from buying your ticket and the goodies and stuff.

Does it make sense? Go ahead.

Yeah, I think that would— or if your employer said that you that he would give you $300 if you came, that would be a greater opportunity loss.

Opportunity loss. So would you say in that sense then the opportunity loss is $300 and the tickets themselves are $30?

Yes.

So let's go to this last sentence. If your next best alternative to seeing the movie is reading the book, then the opportunity cost, we're going back to the opportunity cost of seeing the movie is the money spent plus the pleasure you forego by not reading a book. So now instead of, in his example, instead of missing an opportunity to make $30 or $300, the opportunity cost of the movie is you don't get to stay at home and read a book you love. Does it make sense to call that a cost, the pleasure you forego by not reading the book?

I think so. I get a lot of pleasure from reading books that I definitely— or that I'm really hooked into. And especially if, like, I don't know, it was Harry Potter and the movies are just coming out and you haven't read the books yet, I definitely go and read the book.

Okay, so suppose the friends who are inviting you to go to see a movie are friends you don't really like, and it's to go see a movie you don't really like, whereas there's a book you really can't wait to finish reading because you're almost done and the end of the book is so exciting. Is it— does that change your calculation as to whether you would go to the movie or not?

Definitely, because if it's friends that I don't really like to hang out with and a movie that I don't enjoy, And if I go to the movies, I'm just losing 30 instead of going home and finishing my book that I really like and getting, you know, getting comfortable and not hanging out with the friends that I don't like. Well, then they're not really your friends if you don't like them. But yeah, that would definitely change my decision.

Got it. Well, then let's see at the last, that last clause, the opportunity cost. We're trying to understand the concept of opportunity cost. The opportunity cost of seeing the movie is the money spent plus the pleasure you forego by not reading the book. Does that make sense that the opportunity cost is not only the money you spent, but also the pleasure you forego?

Yes, it does.

So you were talking earlier about opportunity loss. Is this the same as opportunity loss, or is it different? How do you understand opportunity cost now?

Well, just referring to opportunity loss, I don't know if that's a real term. I just thought that it'd be useful to use that because you're losing an opportunity. Yeah.

So here, do you see in which there's a sense in which you would lose— if you went with your friends to this bad movie, you would lose the opportunity to spend that evening reading the book you love.

Yes.

So maybe we'll read the whole thing and see if it makes sense as a concept now. Once more, when economists refer to the opportunity cost of resource, they mean the value of the next highest value alternative use of that resource. If, for example, you spend time and money going to a movie, you cannot spend that time at home reading a book. And you cannot spend the money on something else. If your next best alternative to seeing the movie is reading the book, then the opportunity cost of seeing the movie is the money spent plus the pleasure you forego by not reading the book. How would you describe opportunity cost now?

If you have two options, either maybe one has higher value than the other, and you have to choose what you would like to lose. Between each of them if you'd had to choose. Because if you're going— let's just say you like your friends and you like the movie. If you go and read the book, then you're losing that opportunity by going with your friends and experiencing that with them. But if you go to the movie, then you lose $30 and not reading the book. So you have to choose which option you think has the higher value. And you cost, or you lose in a way, the value of the other option that you didn't choose.

Does it make sense that we're always faced with choices like this? That there's always, we could do this or we could do that, and we're kind of weighing how much we value each option?

Yes.

Um, and does it make sense that Well, I would say, would you already think like this whenever you do something or are asked to do something or choose to do something? Do you always think, hmm, yeah, but I could have done this other thing, and this is how I compare the value of the two things? Do you think that way?

I don't think I necessarily say this is the value of that and then this is the value of that. But I do think in a way where I compare the two and see what outcome I might have of it.

Do you see how being a little bit more aware of opportunity cost might make you be a little bit better at making decisions of how to value different opportunities?

Yes, I do.

Because, and it's tricky, you don't want to be kind of paralyzed by thought because I could imagine somebody at every moment, should I do this? Should I do that? Should I do this? Should you do that? You know, we don't want to be paralyzed. That's ridiculous. But Yeah, I think it's kind of worth thinking about if you don't do action A, especially if it's going to take a lot of time or money. You know, if it's, should I walk into the living room or not? Don't spend all your time overthinking. But if it's like a big thing, should I do this or I should do that? I mean, my bet is if your employer was offering you even the $30, you would definitely think about going to the movie with friends. That is, you would make it a conscious decision. Yes?

Yes. Yeah.

So I think it's good to have this concept of opportunity cost, that the cost is not only the direct cost. So the tickets plus the goodies, that's the direct cost. But the cost is also the opportunity you may have lost. And certainly if your employer is going to pay you $300, that's a huge opportunity to have lost. So, yeah, you kind of have a sense for opportunity cost now?

I do.

Okay, so that's sort of— I, again, I see economics as first let's get a lot of concepts, and once you understand the concepts, then we can build on them. But I would say opportunity cost is a really important concept in economics. Makes sense?

It does.

All right, which case I hope you have a wonderful week, and hopefully I'll see you next week. Bye-bye.

Okay, thank you, Michael Strong. Bye.