Friday, February 2, 2007

Dylan v.s. Clapton: A classic example of opportunity cost

At the heart of economics is a behavioural science. From the choices of the individual to the aggregate (everyone and their dog), economists focus on relationship between economic variables in complex abstractions called models. If you want to know something about economics, here is a classic lesson on opportunity cost - an important concept in microeconomics.

"Opportunity cost" represents the next-best value you gave up by making a choice.

The test question you always wanted:
You won a free ticket to see an Eric Clapton concert (which has no resale value and zero value to you). 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 (because he is so cool!). Assume there are no other costs of seeing either performer.

Summary: the cost and benefit of seeing Clapton is zero, while the cost of seeing Dylan is $40 but - because he rocks you world - he is worth $50 to see preform.

Based on this information, what is the opportunity cost of seeing Eric Clapton?

A. $0
B. $10
C. $40
D. $50

Think about it; harder; harder still ...

Here is the answer:
When you go to the Clapton concert, you forgo the $50 in benefits (represented by your willingness to pay) you would have received from going to the Dylan concert. You also forgo the $40 (the costs) you would have pay to go the Dylan concert. In other words, an avoided benefit is a cost, and an avoided cost is a benefit. Thus, the opportunity cost of seeing Clapton, the value you forgo by not going to the Dylan concert, is $10 – i.e., the net benefit forgone.


Fun eh? Now tell me, what is the benefit of having an extra pint on Friday night compared to the Northend Diner breakfast on Saturday morning? To drink or eat, that is the question. Ok, well we know that most people don't need to calculate the opportunity cost of beer v.s. bacon, and that is the point: Opportunity costs concept helps us describes a behaviours we do each day, just people being people. Doing people things; like choosing between beer and, ahhhh bacon.

Opportunity cost: yours to use, talk about, and even to impress people at on the street.

18 comments:

Matthew said...

I Vote for having the beer and then you would have to eat the bacon to attempt to recover some of the lost electrolytes form the dehydration

Canadian Economist said...

Matthew, thank you for your comment; however, like most economic problems, the example was about making choices under constraints (i.e. only enough money for beer or the Northend Diner). Nevertheless, I see your point: having no binding constraints is better - we always want both.

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