This post is directed at my students in Principles of Micro. Bill Polley directs us to this article by Robert Frank (one of the co-authors of the Micro Principles text I use) in the NY Times (registration req'd) in which Frank opines about the state of Principles of Economics courses. The whole thing is worth reading and Frank has a harsh assessment on the state of collegiate economic instruction in our nation. I want to focus on an example Frank gives on the notion of opportunity costs, a subject my night class students examined Monday night and that my day class students will examine Wednesday. Frank tells us that many professional economists struggle with this basic notion.
"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."
The opportunity cost is the value of your next-best forgone alternative - that value being the net benefit (or economic surplus in Frank and Bernanke's terminology) that you would receive if you chose that alternative. According to the example, your gross benefits from seeing Dylan are $50 (no rational person would sacrifice more than what he'd receive in benefits) and you have to give up $40 for tickets, leaving a net benefit (economic surplus) of $10.
The opportunity cost of seeing Clapton is the total value of everything you must sacrifice to attend his concert - namely, the value to you of attending the Dylan concert. That value is $10 - the difference between the $50 that seeing his concert would be worth to you and the $40 you would have to pay for a ticket. So the unambiguously correct answer to the question is $10. Yet only 21.6 percent of the professional economists surveyed chose that answer, a smaller percentage than if they had chosen randomly.
Shudder, with teeth gritted. Ouch... that's gonna leave a mark!
That last comment by Frank aside, the economist views people as rational and calculating beings. They each compare the costs and benefits of an action and choose that action that has the greatest net benefits among all alternatives. That, my good folks, is the economic way of thinking. Look around you, and you will see that's a pretty powerful worldview: it explains a lot of stuff.