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Action and Choice

September 8, 2011

“All we have to decide is what to do with the time that is given to us.” – J.R.R. Tolkien

Economics is the study of human action. Humans are purposeful; we act to achieve goals. The goals may be simple or complex, altruistic or selfish, short or long term. In order to complete goals and satisfy desires, people need to use scarce resources, such as time, natural resources, information and effort. In a world of scarcity, people must make choices between which goals they want to achieve and which goals they cannot, because each action consumes resources. Earth has but so many resources and resources used to satisfy one person’s goals often cannot be used by others.

People choose between alternate uses for the resources at their disposal. So, if you spend your time playing Minecraft, you cannot also spend that time writing economics blog posts, for example. If you spend your money on restaurants, you can’t spend the same money on electronics.

In order to decide which desires to satisfy, people weigh the costs and benefits. Costs are aspects of the consequences of their action that people don’t like, and benefits are consequences that they do like. The costs and benefits of each action are entirely subjective. There is no objective way to compare value between people, since value only exists in the minds of individuals. Something that one person likes a lot might not be valued at all by someone else. Choices are made by comparing the costs and benefits of one alternative course of action to the costs and benefits of other alternatives.

Economists call the value of the best option which is not taken the opportunity cost. Opportunity costs are a way of thinking about why people choose the things that they do. When people chose, they imagine what the future will be like for each possibility. Let’s walk through a simple example. Someone has some free time in the evening and must decide what to do. They think of three alternatives:
1. Watch a movie.
2. Go shopping.
3. Exercise at the gym.

They then imagine the consequences of each action:
1. Benefits: Fun, relaxing, low effort.
Costs: Money for movie tickets, time to drive to the theater.

2. Benefits: Get new stuff, it’s fun to see new things in stores.
Costs: Expensive, and maybe you won’t find anything you like.

3. Benefits: Get in shape, endorphins.
Costs: Requires effort and discipline. Rewards are long term.

So, the person has three alternatives to use the time and money at their disposal. Suppose after weighing their options, the person decides that the movie is their best alternative and shopping is second. The opportunity cost is the subjective value of the trip to the store. The opportunity cost is not paid, in the sense that the costs and benefits of that option are never confronted in reality. However, opportunity cost is the only cost that matters for choice. For an alternative to be an opportunity cost, it must be known to the chooser and feasible. If a person is not aware of an alternative, they can not choose it. When attempting to explain choices that seem bad, ask yourself what alternatives the person has.

Cake or Death

No one will pick death, even if they really really don’t like cake.

Snickers Bar

Yoram Bauman confuses the measure of utility (for comedic effect; his own intro to economics book is clearer than Mankiw, actually), which depends on the action actually taken, with opportunity cost, which is the method economists use to explain choice. There is no choice if your only alternatives are two identical Snickers bars, so the consumer surplus (the difference between the opportunity cost and the actual choice) is zero. In terms of consumer welfare, being offered a choice between two identical Snickers bars is identical to just being offered one.

Rocks vs. Hard Places
When people make choices that seem bad to an outsider, it is often the case that their other alternatives are even worse. For example, in rich countries, child labor is considered abhorent. Why would a parent force long hard hours of work in harsh conditions on their child? However, in the rich world, the chances of a child dying of malnutrition or from a cheaply preventable disease is very low. Likewise, the return from education is much higher. Let’s compare the opportunity costs in the rich and poor world for child labor.

Rich country:
Benefits: $1 a day. Costs: No education, child is miserable.
Alternatives: Study in a comfortable school, learn things that will improve future life.

Poor country:
Benefits: $1 a day. Costs: No education, child is miserable.
Alternatives: Die of starvation/easily preventable disease.

It’s not that working in a sweatshop is good in the absolute sense. People choose it because their alternatives are even worse. If the alternatives are bad enough, choices that seem bad will be chosen anyway.

Further reading
Dan Gilbert on Expected Values

calvin and hobbes chain reactions

10 Comments leave one →
  1. September 8, 2011 5:52 pm

    I’m glad that you specified that the alternatives have to be known (and feasible) to the individual. That helps me understand opportunity costs a bit better.

    My question then is on the terminology “cost”. In your recreation example, if the person orders their preferences movie > shopping > gym, then the “opportunity cost” for choosing “movie” is “shopping”. What if you were then to introduce a fourth option, say “video games”, that the person prefers to shopping (but still prefers movies most). Does taking the action “movie” then become “more expensive” because the “opportunity cost” is now somehow “higher” than it was before? I don’t even know if it makes sense to talk about things this way. Hopefully you can enlighten me!

    • September 8, 2011 7:04 pm

      This article might seem familiar since it is a rewrite of an old livejournal post I did. It was your comment on that post that caused me to add the “known and feasible” to this article.

      To answer your question, yes. The closer in value an alternative is to the action taken, the higher the opportunity cost. As Yoram Bauman points out, the highest opportunity cost you can possibly have is when you choose between two identical alternatives.

      Opportunity cost is different than cost in that regard. A normal cost is an aspect of an alternative that the actor does not like. So, if the movie theater is really cold and you have to bring a sweater, that is a cost. If there is a really good video game that you want to play instead of seeing the movie, that is an opportunity cost.

      I don’t like the terminology of opportunity cost, since I think it is confusing. I prefer talking about alternatives and then costs and benefits within those alternatives. The costs and benefits then impact which alternative is actually chosen.

      Opportunity cost does affect cost when it is introduced into price theory, which I will cover in the next “intro to micro” post.

      • jamesoswald permalink*
        October 21, 2011 12:19 pm

        I think I missed the point of your original question. Only one alternative is the opportunity cost: the highest valued one. Otherwise, it would go up and up as you thought of hundreds of low valued but feasible alteratives.

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