By Philip Pilkington, a writer and research assistant at Kingston University in London. You can follow him on Twitter @pilkingtonphil. Originally published at Fixing the Economists
Recently Cameron Murray directed me to an interesting paper entitled Do Economists Recognize an Opportunity Cost When They See One? A Dismal Performance from the Dismal Science. The paper surveyed a whole bunch of professional economists to see if they could answer a basic question on the microeconomic theory of the ‘opportunity cost’.
The results were not so good. They are laid out in the table below — note that there is only one correct answer!
Most of the profession viewed this as some sort of failure of economic education. So too did Murray on his blog. But I’d like to put forward a different interpretation: what if the entire technical idea of opportunity cost is a load of rubbish?
What do I mean? Well, in order to get where I’m coming from take a look at the question that was asked.
The correct answer is B, by the way. This is because we have to take the subjective value of the Dylan ticket into account, that is $50, and then subtract from it the actual cost of the Dylan ticket, that is $40.
This, as we shall see, is a very particular way of measuring worth. Indeed, it is little more than an accounting trick based on a priori definitions (opportunity cost = potential utility – actual cost) that tells me nothing of substance about the subjective valuation. I can just as easily come up with a new accounting definition; this is entirely arbitrary.
So why do I say that the results prove the theory to be garbage? Well, because each question got somewhere around a 25% response rate. They seem to be, as the paper notes, basically randomly distributed.
And why does this imply that the theory is garbage? Because in microeconomic theory people are supposed to maximise their subjective utility. In order to do so they obviously have to be able to calculate the opportunity cost of forgone purchases. But if economists cannot even do this then why would we expect anyone else to do it?
Let’s go one further. Let’s assume that all of the economists had a vague notion that opportunity cost meant “amount of utility forgone in order to gain another amount of utility”. Then we can also infer that all the economists had different subjective conceptions of how much utility they were forgoing in order to go to the Clapton concert.
This is not actually unreasonable. I can see how people could view this in different ways. I could say, for example, “well the Dylan ticket is worth $50 to me, so I’m giving up $50 worth of utility to go to the Clapton concert”. Indeed, according to the responses this seems to be what most of the economists thought.
Alternatively, I could say to myself, “well, I prefer Clapton to Dylan so I’m not really giving up any utility at all because I don’t care much about counterfactuals or alternative universes”, in which case I would choose answer A. This all depends on how I view placing worth in something which ties back to the idea I put forward earlier that the a priori accounting definition underlying the question is arbitrary.
While only one answer is correct given the definitions laid down in microeconomic theory, this does not mean that any of the choices made by the economists when they placed themselves in the subjective position of the concert goer was incorrect. They simply manifest different manners in which different people order their preferences.
The way that I order my preferences or you order your preferences is not subject to objective judgment. If I choose to view the Dylan ticket as being worth $50 and hence that I am forgoing $50 worth of enjoyment to attend the Clapton concert that is my business, not your’s. (I can even make a pseudo-sophisticated argument based on the fact that I have very limited time and that carrying an extra $40 in cash with me to the Clapton concert does not yield me any utility at all).
This ties back to the tone of the paper. The tone fits into what I have said before about marginalist microeconomics being a manifestation of normative ethics. You can see that the authors of the paper are chastising the economists for not… choosing as economists should choose. This implies that their training should have made them choose in a predetermined manner.
The point is that the idea of opportunity cost is counter-intuitive to how many people (apparently 78% of economists!) actually think when they are weighing up their subjective preferences. This casts serious doubt on whether any theory of behavior based on it is useful for describing the real world. What’s more, trying to subject people to a normative view of how they should view this is an act in moral indoctrination. It has little to do with economics in any sense I understand that word.
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Never been able to grasp opportunity costs. Eric Clapton might have decided he would be be happier returning to drug abuse that evening, Bob Dylan could have have another motorcycle accident on the way to play, or you could have just blown the dough on scratchcards.
You could lose out either way…but at least OC would allow you to quantify the loss, carrying that bitter regret with you to the end of your days.
I don’t like the economic use of opportunity cost and tend to think of such in much cruder terms. More or less ‘what might we have had if we hadn’t done this failed piss-up in a brewery’? In business one wants to ask this “opportunity cost” question before investing in the failure.
Various studies by psychologists (see, e.g., several articles in Kahneman et al. 1982) are taken to show that people commonly violate the usual probability calculus in spectacular ways. Only economists could be so arrogant as not to do enough reading around to spot that their basic assumptions come from a book of spells.
Kahneman, D., Slovic P. and Tversky, A., (eds.), 1982, Judgment Under Uncertainty. Heuristics and Biases, Cambridge: Cambridge University Press..
Opportunity cost in this sense is supposed to open up the relationship between scarcity and choice – but let’s face it, economists need to get out more. I used to teach biochemistry to medical students. They were very good in the exams, but tested in the first class of the following year, had generally forgotten all. The economists might just have ordinary memories, which are crap. They’d have been a long time from whenever someone taught them opportunity cost definition. I only remember because I found it howling stupid at grad school.
I suspect, say, me and Craazyman might have put up a payment in kind for free Clapton tickets, so the final opportunity cost calculation might well have included a being nicked by vice complication at the Dylan concert. Of course, economics is never interested in what people actually do. Where was the control group of economists briefed to refresh its definition of opportunity cost?
During the August 11, 1999 solar eclipse in the UK, a man placed a bet that would have paid a million pounds if the world came to an end. In subjective probability, an agent’s degrees of belief determine his estimates of certain quantities: the values of bets, or the desirabilities of gambles more generally, or the probability assignments of various ‘experts’ — humans, relative frequencies, objective chances, or truth values. The laws of probability then are claimed to be constraints on these estimates: putative necessary conditions for minimizing his ‘losses’ in a broad sense, be they monetary, or measured by distances from the assignments of these experts. Those wanting to place world coming to an end bets should send the money to Craazy’s off-world address mentioned in a previous post. Dylan fans who have just attended a $40 gig and wanted to pay $50 should send the $10 to the same destination.
Most people can be suckered into Dutch Book agreements. They place subjective value on having a series of bets, but are dumb enough to be suckered into objective losing. A mate who would normally pay (lose) $100 to Dutch Book scammers, but they have only structured a $90 book today. You drag your mate away before he can do his subjective thing. You both get into a Dylan concert free because he knows the roadies. Work out the opportunity cost, who buys the first round after the concert and what you do in the morning when you find the tickets to a musical you were meant to attend with your partner, and whether this gets worse when you notice the tickets are for tonight.
Seriously, why use the rationality bag at all when other concepts like coherence allow people to be smart, ignorant, daft and what they actually are?
Off on a tangent: How did the bettor expect to collect if he won?
Most of the economists don’t really believe the premise that Dylan tickets are worth 50. Also, most of them are so well off that the ten dollar difference is to them indistinguishable from 0. These people routinely drop 50 dollars on dinner. Their problem is psychological. Also they don’t really accept their own idea of utility, as they make all valorations in purely monetary terms – they can’t distinguish subjective valuations from monetary valuations – for them only the former exist.
I’d cheerfully pay $100 for a third option.
:D
I would too, especially if it didn’t involve the standard formula for what is music nowadays: Guitar, singer, bass, drums, 4/4 time signature on every single tune, zero dynamic variation, same-old same-old progressions (“okay, for the chorus, let’s just go to the IV!!”), so-called musicians who don’t know why it’s correct to say an A major triad should be spelled with C# instead of Db, etc.
Then again, the next door neighbor was just yesterday playing a, um, tune that had literally two very loud house-shaking bass notes and a beat (4/4 of course) over and over again as its musical content, so there’s always room to go even lower into the depths than the above formula.
I seriously need to escape this culture, but it seems to be infecting the entire planet at something beyond plague pace.
As a former percussionist (I don’t gig anymore) I appreciate your frustration about 4/4 time–I always loved playing in other time-signatures even if I had to struggle–in fact, it was the struggle that was rewarding and, for me, music like art works best when there is a struggle or tension involved because concentration is required—with 4/4 it’s easy to fall asleep playing.
Ya, 4/4 has always been the most common time signature, of course, which is why it’s called common time, but it seems to me they should rename it all the time. :)
I dunno, I doubt things like 3/4 or 6/8 are totally dead, but I consciously look for these once ubiquitous time signatures and I never hear them at all anywhere. As far as I can tell, the waltz is gone, gone, gone. And there are whole modern music genres where I’m pretty sure anything but 4/4 is considered illegal.
As far as I can tell, the most common music consumption pattern is something, anything to avoid having to listen to oneself think. The second must be parties, and how’s a clumsy white guy like me supposed to dance in 13/6 time without getting REALLY drunk?
I understand. Although there’s no such thing as 13/6 (the second number is about which note type is carrying the beat, e.g. quarter note = 4, eighth = 8, etc), anything in 13 would be pretty out there, but it can and usually will be chunked up into something like 3 + 3 + 3 + 4 = 13 or any number of things like that, so the listener can be fooled into hearing it as a little odd, but it normalizes in the ear if its repeated again and again. The Stranglers ‘Golden Brown’ intro works this way. Admittedly, Bill Turnbull famously tried to waltz to it a few years back and pronounced it “undanceable.”
https://www.youtube.com/watch?v=d7R7q1lSZfs
In any case, once a rhythm is established as solid, a groove can be felt in all sorts of meters, even if they are oblique. The Beatles ‘All You Need is Love’ is in shifting meter, much of it in 7, but I’ve never heard any non-musicians being too confused by it. Not the most danceable thing in the world, but I’m sure it’s been done! Lots of prog is in 7/8, and people have managed to dance to it.
One of the two meters I identified, 3/4, has been a standard dance rhythm for the entire history of music and is absolutely normal in its rhythmic feel, by far the most common meter after 4/4. All waltzes, minuets, mazurkas (a Polish dance) are in 3/4, and plenty of rock and pop has been done in this meter over the years. Likewise, 6/8 can be felt as 2, so it’s very much related to 4 that people love so much.
At any rate, even in pop not everything is meant to be danced to. But I can understand if that’s the only reason certain people like music. I just have to shrug a little bit on that one.
Don’t dig the boom-whack, boom-whack of typical American music? This will help:
https://www.youtube.com/watch?v=JwGE3zhkzNQ
That’s rumba in central park, and it’s got 3s and 4s going on all the time (and probably even 2s, 5s and 7s if you listen close enough).
And if you need something a little more on the conventionally-pretty side of things, might I suggest the group Light in Babylon, which a percussionist friend turned me on to yesterday:
https://www.youtube.com/watch?v=aKJvbTEnp0I
I like both of these. In terms of time, the first clip is 6/8; the second 4/4. They’re both traditional musical forms, though, and that’s my own musical bailiwick (I’m a classical and jazz pianist – mostly classical these days – who delights in various ethnic musics, but I’ve been in just about every type of band there is that uses keys too over the years since roughly 1988). There are modern forms that break the mold, even some I have almost no interest in (like jazz fusion, prog rock, certain jam bands), so I’m no absolutist in what I was saying.
Culturally though, the bulk of my students – once they hit puberty – become less and less interested in anything traditional, and these days the acceptable genres are more and more limited among them, and that sort of freaks me out.
“…In terms of time, the first clip is 6/8…”
I imagine my rumbero guru would respond with something to the effect of “thinking about it (and feeling it) in terms of 6/8 is a western way of thinking about the rhythm–in reality the pulse is based around the clave pattern.” Or something like that…I’m no expert.
But consider, in a rumba group playing, say, bembe, you’ve got the quinto player holding the four quarter note, the segundo playing a 3/4 pattern, and the tumba improvising in 6 over the top, with a 6/8 clave. So the feeling, at least when I’m playing multiple parts, is different than a western 6/8 feel. For me anyway. Regardless, it’s super-cool, and fun to play…
of course, I still obviously think about the patterns themselves in western notation…which either invalidates my supposed point or shows what an irredeemable white-boy I am…
I just count the beats and the accents, and it’s a 6 feel once they enter the groove about 10 seconds in – i.e. 2 in triple meter. I do not differentiate between western and eastern thought processes at all and don’t really think about such stuff as long as I would be able to drum with these fellows all night long, which I could quite easily. :)
Writing something as 6/8 + 3/4 is not out of the ordinary. As long as one understands that the measure length is the same it ends up being either a polyrhythm or merely a matter of accent. Debussy wrote Les Collines d’Anacapri in 12/16 = 2/4, for instance*. Any accomplished musician can play 3 on 4 and 2 on 3 easily, though not all things like this are easy (for instance 5 on 7, where you have to subdivide the beats by the least common multiple of 35). I remember my old teacher had a horrendous time juggling 5 on 7 on 13 in one solo piano piece though, undoubtedly some ridiculous modern batshit academic work.
*Found a youtube video with the sheet music of this, so you can see it as it plays: https://www.youtube.com/watch?v=71SqlSco97U
Music for youth has a mark of group identity, and I think it has been ever since kids had the ability to play the recorded music of their choice on their own personal equipment. I suspect that the industry actively tries to make their output so hyper-stylized it’s unlistenable to those who didn’t grow up thinking that was what music was supposed to be. Which has the added bonus of raising the barrier to entry for producers because the kids won’t touch it unless the vox have every last ounce of expression auto-tuned ($99, please) out of it. The other added bonus is making inter-demographic solidarity unpleasant.
I agree. My own history supports it too. Long story short: In high school I was a classical geek head, in love then as I am now with Chopin and Beethoven, etc, and not afraid to say it. In 10th grade I decided it wouldn’t do socially, and since most of my friends were into punk, I put on the uniform and listened to that for a while, and lo and behold, people were nicer to me, girls started liking me, bullies didn’t bully me, etc. Pretty horrible, but so it goes. And it’s funny too, since punk is supposed to be nonconformist while classical is supposed to be just about the pinnacle of musically conservative. That’s not how teenagers work, however. :)
R. Crumb, the artist, talks about this sort of thing in his work. In the 1960s he was right in the middle of the burgeoning Haight-Ashbury hippy scene, a scrawny completely un-sexed geek, and as soon as he did the Janis Joplin album cover he was instantly popular, man of the party, beautiful women chasing him, etc.
Listen to Riverdance, music by Bill Whelan.
It uses so many unpredictable asymmetrical meters, owing to the influence of a Bulgarian percussionist (who played the bodhran) who worked closely with the Irish composer. I think this is a huge factor in the show’s success.
holy smokes this is complicated. It’s no wonder it’s a mind pretzel that crunches the minute you sink your teeth into it.
first of all, you could go see Bob Dylan any night, all other things being equal. So there’s no opportunity cost to not seeing him THE SAME night. You could see him next time he’s in town, or even the night before!
The opportunity cost is really giving up staying home and laying around, smoking some reefer and checking them both out on Youtube. That’s free, except the reefer. So there really is no opportunity cost. Unless the opportunity cost is the utility you’d have foregone by not laying on your floor at home getting stoned in front of Youbute (minus the foregone cost of the reefer).
The actual answer is e) none of the above Unless they give you a number for the cost of the reefer and whatever wine you’d have drunk. Then it’s that. Totalled, subtracted from the utility preference quantity, which is probably 56. so it’s 56 minus reefer + wine. Don’t bring Led Zepplin into this or the math ggets too complicated
The right answer Craazy. But that’s why you aren’t an economist. You fail the first ethics test by refusing to see the world n their infantile sum.
you could even stay home and read Milton Friedman’s “Monetary History of the United States” or, if you really want to blow the doors off the calculations, something by Ludwig von Mises. How can you even quantify the opportunity cost from the loss of utility you’d experience? it seems unfathomable.
well I’d be drowning deep in the sceptic tank with those two. better leave them for after the stella artois and something from uncle ho.s victory garden.
Just to be clear, I meant the “universal you” not you you. Somehow I don’t think you’d do something like that. :-)
Just to muddy things up again, I meant septic tank.
Yeah, and even if we accept that going to either concert seems likely to give us more pleasure than laying at home with youtube and reefer would, before the fact, what if you end up standing all night next to the super-smelly guy at the show, or the chicks who have to scream out the lyrics to every single song, and then end up regretting you every left your couch? What’s your opportunity cost then? Are we measuring before or after I have the frat guy barf on me in the mosh pit?
that depends on how hot the women are. there are so many variabulls my utility function burns out and I can’t get my butt off the couch
Which goes to show, had you both paid attention in my class after I sent that chap out to find out what opportunity costs were, you would be able to do these sophisticated sums and have the opportunity to get off the couch more. Or was that the year I took the opportunity to teaching leisure by sleeping in a hammock?
By the time you figured the math out, you’d probably have already missed the first set.
Thanks for the laughs, craazyman, allcoppedout and diptherio. Good stuff.
I think the results say more about economists as a group than about the theory. Reading comprehension and concern human decision-making may be lacking somewhat.
It appears they know all-too-well the ‘opportunity cost’ of speaking out about moral hazards like: “subprime is contained” bailouts; “foaming the runway” abuse; “light touch” or “serve the industry” regulation; QE give-aways; etc.
It’s probably worth mentioning too that practical irrationality, known as akrasia, incontinence, or weakness of will, and its nature and even possibility are traditional subjects of philosophical speculation in their own right. So I know I should already be working on finishing a conference paper and not in here. And worse, when I finish here I should finish the paper, but am off to the pub with some old army mates, who have shown up out of the blue like the best bad pennies I can think of. Assuming that this strong kind of practical irrationality is possible, we must grant that practical reason is not automatically practical in its issue. A more accurate way to represent the consequences of practical reason would be to say that deliberation about action generates appropriate intentions insofar as an agent is rational. And if human beings were predominantly rational there would be sensible politics, no advertising, a completed paper on ‘no data or science in economics’ and no visit to the pub.
These lads were there for me. One might read Scanlon, T. M., 1998, What We Owe to Each Other, Cambridge, Mass.: Harvard University Press. Economics has just been there, as I’ve seen no action on a better world and a slide into serfdom. We should be very suspicious of it.
ahem, there’s no date for the concerts….
so back in the ’60’s the cost to me might have been $40 depending on who else was playing, so split the difference and call it $20 = bargain
but today my concert would be free, whoopee….so sorry Bob, nothing personal
The correct answer is: spend $15 to go to a concert by a struggling band or artist that needs the money.
A Local struggling band or artist … and in a local struggling venue … and keep the money in the community.
On the bigger question, how does an Economist calculate the opportunity cost associated with the possibility of running into the artist in the alley having a smoke at the break or of getting into a chance conversation with either the woman of your dreams or a potential business partner while standing in line for an overpriced drink at the intermission bar? I love how homo economicus has no life and has no fun and everything is bought (or sold) … life happens in spite of the money (good and bad) in my experience.
I know, right? I often stand in lines without even knowing what they’re for, just on the off chance that I might end up meeting my one true love…admittedly, I have a lot of time on my hands….
…so the opportunity cost is low…
Wow! I remember having a long conversation with an economist many, many years ago about putting dollar costs on all human interactions–it seems there was this whole sub-section of economics that was putting some kind of cash-value on everything–making the entire universe one big market. So if I said something to displease my wife I could put a dollar cost on what it would cost me in dollars and so on or what it would earn me if I bought flowers–if I bought flowers for here I would gain $20 thereby offsetting the actual cost of my flowers and so on.
I wanted to take a baseball bat to the guy’s head–but he actually was a nice guy so I didn’t.
And that last line is the really worrying bit. Most of them are nice people, and think they are doing good by putting forth recommendations that drive the world towards that X on the graph…
Next time offer him a deal on the Sea of Tranquillity, but don’t tell him the Spaniards have already fished it out. I’m into a deal to sell American pop-psychology to the economists Banger. Want a piece of the action? I may need a good man with a baseball bat when they discover it’s as much use as a trout farm plan on the moon. Though on the basis of this post they get their information from Australian newspapers:
http://www.smh.com.au/business/at-the-coal-face-economists-are-struggling-to-measure-up-20140418-36wde.html
So with Skippy running some interference we may have a good run and hit them with left-brain, right-brain hemispheric differences (discredited 1987) after they work out they’ve been in a Dutch Book opportunity cost shell game.buying derivatives tranched on outdated textbooks.
So if he kept talking about it up to the point where you would be willing to pay him $50 to stop, would he have created economic value?
And seriously, how to “account” for intangibles is really important. Yet how can we do this, in a form that we can compare say two different businesses or activities (e.g. including all social / community / cultural / environmental pluses and minuses, in addition to the financial balance sheet)??? Attempting to translate everything into financial terms is a nonsense, as you point out.
Limiting a business’s required filings to the financial dimension excludes practically everything that really matters, IMHO.
Who cares if company Z makes a huge profit, for example, if its products destroy people’s health and also reduce or eliminate a locally made alternative healthy option?
What % of products, services (or “work/jawbz”) actually makes the world a better place? The “less-developed” communities would probably run circles around all the multinationals, but a money-only balance sheet or P&L would not reflect this.
Aside from the arbitrariness of the “correct” formula in this post, the inability to “account” for intangibles is a real and present challenge when we want to compare one entity or group of entities with another.
Suggestions for a student in need of a topic: Formulate definitions for opportunity cost which would make each of the wrong answers right. Substitute the new definitions in some famous papers using opportunity cost and see what difference it makes. Advanced: see what happens if you spead the four definitions evenly in the same papers.
Thank you Dr Mankiw.
So, it could be considered that the class of person who places value in this concept of opportunity costs would be— Opportunists?
The correct answer is 42;)
I believe that the primary purpose of the dismal “science” is not to discover truth, but to give intellectual justification and rationalization for making poor people miserable. And incidentally most rich people want to kill themselves too, more or less. Another words, it’s symptomatic of our F-ed up society that sort of rolls along under its own momentum.
If “the correct answer is B [$10]….” for the reasons given, then:
A) go see Clapton for $0, or
B) go see Dylan for $40 (the going price),
the opportunity cost is the same no matter which is chosen?
Is that right?
I think the proper conclusion is that we can easily fire 3/4 of econ professors. Oh but wait, then they would have to get a real job. We can’t have highly educated intellectuals making $8 an hour. They have PeeHDees!
But in all seriousness, I would say this actually isn’t a critique of economics. This is a critique of an educational system that uses stupid test structures. The fact that the answers are so evenly divided is a great clue to this. The respondents were some combination of apathetic and reading into the question what they wanted to see. A good test taker could answer that question without even knowing what opportunity cost is. $50 and $40 are mentioned in the text. $0 is highly unlikely in this kind of formulation. Therefore, $10 ($50 – $40) makes sense purely on a test-taking guess of process of elimination. That economists are poor test takers makes them human. That this question does such a crappy job of probing the concept of opportunity cost speaks to the awfulness of education in general, not the particular awfulness of microeconomics, I’d say.
My guess is that what the results of this survey shows is that most economists just have no use for the concept of opportunity cost, not even microeconomists. Opportunity cost is a piece of old-fashioned lore that hangs around in some of the textbooks and was superseded by more comprehensive decision theory techniques that can be applied to choice situations in which there are more than two alternatives. I assume that if you gave economists all of the same background information as is supplied in this example, and then asked them to do a cost-benefit analysis of the two choices, a much higher percentage of them would come up with the same results.
Well said.
Personally, I just can’t relate to what the author describes here. I thought people interested in decision-making are interested in concepts like discrete choice and game theory and asymmetric information and transaction costs and so forth, not mechanistic calculations like opportunity cost = potential utility – actual cost.
I wonder what Pilkington thinks of efforts like Stiglitz and Bilmes’ The Three Trillion Dollar War? Is it bad because it explores the subjective costs of war in terms of a common unit of measure called the dollar?
Economics is all about making mathematically optimal decisions based on information that no one can know. Or that maybe cannot even exist, in the nature of things.
As far as the war is concerned, I think most of us can probably agree that the correct decision would have been not to go, without any regard to whatever digit may precede the string of nine zeros.
So the various schools of economic “thought” are civil religions. Sounds about right.
For me opportunity costs makes even less sense when it is used to show savings.
Example:
Company A wishes to procure engineering services from Company B. Company B’s initial offer is $2,000,000 to provide engineering services. Company A counters with an offer of $1,750,000 to procure Company B’s services. Company B agrees to the offer of $1,750,000 to provide their services. Company A records the payment of $1,750,000 but also boasts of a $250,000 savings. But the truth is, there was never a $2,000,000 settlement and in all likelihood any money not spent on the deal will simply be spent elsewhere.
People seem to have a hard time simply saying “I spent $X to get items/services $Y.”
They have a tendency to treat “money spent” as a “loss” and they seem to forget that the item/service they received “is the money they spent”. I think loss aversion creates this need for stories/justification about deals that never existed and fictitious savings.
I can understand the motivation for claiming a $250 savings in the example you gave. In a corporation where there is a practice of trying to make every business activity and employee a profit center, employees who work in cost centers (that will never generate a profit) must invent fictional profits in order to compete for their share of the incentive awards. So procurement managers and procurement departments invent these fictional savings to count as profits on an argument that a penny saved is a penny earned. Legal departments resort to similar arguments: as in, “we saved the company $10M, by settling for $20M when we could have lost $30M if we had gone to …[trial, or arbitration, or the regulatory proceeding, or whatever …]”
Thank you for the reply.
“So procurement managers and procurement departments invent these fictional savings to count as profits on an argument that a penny saved is a penny earned.”
Funny thing is, I have watched people use the same logic in to justify what they spend on cars, homes, etc…
Advertising encourages us to think this way. (“Buy this product now–you’re saving $10 because of a today-only sales price.”)
I went through a rigorous engineering school which required all students to take IEMS 326, or Operations Research. Everyone thought it was a joke. We routinely made fun of IEMS students (industrial engineering and management science) which we called “Imaginary Engineers”.
Then to fufill credits I took a high level Econ course “Corporate Finance”. I thought Operations Research was a joke, but this course took the pie. I could not believe how unsound and untested the theories were. It was like someone decided to, through simple “logic” derive theories that, for the most part, have very little to do with reality. One thing you begin to realize after years of hard science is that everything is connected and poorly understood. Equations that govern life actually govern chemical reactions as well. Why should economics be any less complex? If anything, it should be the MOST complex since it deals with humans, who do not react solely on….anything really.
The depressing conclusion you also begin to see is just how goddamn little we know, and how the media portrays our scientific understanding as going through leaps and bounds everyday. Its BS. Its actually such BS, that recent efforts to simply parse through scientifically reviewed and published papers have found hundreds upon hundreds of falsified statements, conclusions, results etc. The EECS association actually found about 11 papers that were created by a computer program developed in MIT.
My own experience has been equally as disheartening. My former masters degree prof actually asked me point blank whether it was OK to lie about the PH of an experiment to make it seem like fungi could in fact live in concrete. The hilarity ensued; after reviewing papers about this so called “self-healing concrete” I realized that the initial paper, which was on the cover of a Scientific American, was completely false, and that the results were not due to any living organism but simply a compound in the fungi cell wall.
The morale of the story is that just ONE single false paper spawned about 14 more on the subject, with wild claims of being able to, “in 20 years or less” make buildings out of self healing concrete. So imagine that in economics, where many of the underlying principles are essentially bullshit, how much more bs has created from bs. And thus we get these “economists” who all have different views. Not surprising at all.
The presentation quality of this question along with it’s orientation should be reviewed. Answers to questions can be skewed depending on quality and orientation. My interpretation is that the authors of this question are just shitty political pollsters.
Regarding education, IIRC (’76 to ’79), the construct of “opportunity cost” was presented not only in my microeconomic courses but also in general accounting II, managerial accounting, production and operations management, and finance. Oh, hell, it was probably presented in my philosophy courses of ethics and logic as well. Perhaps one could argue that the construct of opportunity cost is just a nasty infection or inescapable pollution.
I sympathize with desire to give people tools to improve or clarify the choice-making process, and to allow things to be compared. The trouble is, the tools don’t work and real life isn’t like whatever guidelines one might use.
Perhaps evaluating the balance of any choice has to be learned by feel, combined with lots of hindsight. . .
Note to Yves: Dear Yves, this thread, from Pilkington to whoever has the last comment, is an Odyssey. It’s the most amazing thing I have ever read on NC. I wish you could publish these masterpieces of reader harmony – it’s way more beautiful than music. Maybe use your copyright and then sell it for a dollar and make some money for NC off these guys!
In the actual textbook, instead of asking about opportunity cost, the question is this: “Based on this information, what is the minimum amount (in dollars) you would have to value seeing Eric Clapton for you to choose his concert?” It really should ask about indifference, but that is a better question, since it gets at the meaning of opportunity cost.
Now, there is a real question whether human preferences or utilities can be reduced to monetary values, but that is an upfront assumption of the question.
Let me pose a different question. Based on this information, how much would your net gain be, in terms of dollars, from buying a ticket and going to the Dylan concert?
What percentage of the economists surveyed would get that one right? A very high percentage is my guess. But, of course, that is the same thing as the opportunity cost of going to the Clapton concert. {shrug}
The problem, I think, lies in the terminology. The authors state: “An avoided benefit is a cost, and an avoided cost is a benefit.” While that makes perfect sense to a mathematician, for whom the question is where we place the zero, it does not reflect how people think or use language. In ordinary parlance, if I have a choice between two identical items and pay $50 for one when I could have paid $40 for the other, then I may say that my cost from making the wrong decision was $10. If I pay $40 instead of $50, I may say that I have gained $10, but I know that there is something funny about saying that. I could go broke making gains like that. ;) My cost is still $40. If the alternative price was $100 instead of $50, did I save $60? Whoop-de-do! You can see why a lot of non-economists think that opportunity cost is ridiculous.
My hypothesis as to why so many economists got the wrong answer is that, unless they actually thought about opportunity costs regularly, over time their original understanding of language came to the fore and overshadowed or confused the terminology that they had learned. I suspect that they still did better than a group of, say, anthropologists would have done. (The lack of experimental control is a flaw of the study.)
In my comments on economics blogs I often assert that the terminology of economics clouds men’s minds. Usually that is because of classist aspects. This may be another example.
The true definition of opportunity costs at last, perhaps, Susan.
I suspect that the difference in responses may due at least in part to incomplete information, so that different people presented with this choice were making it based on different assumptions. Any number of scenarios can be imagined that would influence the choice. This is the problem generally with cet. par., as well as assumptions about rationality, which abound in economics.
For example, wrt rationality, in Nichomachean Ethics, Aristotle posits that every [rational] agent acts for an end that is some good. That good is generally agreed upon as “happiness” (eudaemonia). Aristotle then observes that people disagree over what happiness is and how to achieve their conception of it. Most of Book One is clarification of the various views, followed by Aristotle’s own view of happiness as the by-product of excellence over a full life, i.e., maximization of potential as a human being and unique individual rather than maximization of “utility.” The definition is not operationalized since it is chiefly qualitative rather than quantitative — about building character rather than acquisition of economic goods.
The economic conception of rationality is based on Aristotle’s assumption, stated as a causal principle, every [rational] agent acts for an end that the agent perceives as a good. The utilitarian assumption also is that the generic end is “happiness,” meaning satisfaction. There is no investigation of other views, nor is there operational definition of key terms. It’s a common sense assumption based itself on “rationality.” Therefore it begs the question.
Moreover, as a universal principle (psychological law) it is stated wrt cet. par. This provides the out of exceptions so that the “law” can never be tested. While the Mises version in Human Action is perhaps the most obviously a priori and specifically stated to be non-falsifiable the presumption of purposiveness (volitional teleology) is no less so by grounding it in “common sense,” or generalizing from personal introspection, or just asserting it as given. Or even operationalizing it based on too limited a sample.
Geoffrey M. Hodgson, On the Limits of Rational Choice Theory
http://www.geoffrey-hodgson.info/user/image/limits-rational-choice.pdf
Reading economics from the POV of a former philosophy prof., it strikes me that the way many economists operate is as philosophers grounding their argument deductively in “reason” rather than scientists ground their work inductively in empirics. That’s speculating rather than doing science. Perhaps the outcome of this test on opportunity cost is suggestive that opportunity cost is insufficiently operationalized, so that a variety of answers are “rational.”
Haven’t looked at the paper yet, but an obvious exercise would seem to be asking an open ended question, as opposed to multiple choice. In addition, it would be interesting to see if economists were able to correctly define opportunity cost. It seems like a mistake not to include this question in the survey. (Hopefully they did.)
I don’t quite understand one aspect of Pilkington’s post. The question tells the respondent the subjective value of seeing Dylan, namely $50. This fact seems to curtail somewhat reasoning about the concept of opportunity cost. Pilkington writes:
But the economists were told what their subjective value was: “you would pay up $50 to see Bob Dylan.” So this seems more like economists having a hard time with a hypothetical question (they are bad at taking tests, maybe), or not understanding or knowing the definition of opportunity cost. It is too much of a jump for me to think this should count as evidence that opportunity cost is a not useful concept as defined.
The authors of the survey question didn’t understand the concept of opportunity cost well enough to formulate the question properly.
Beyond that, I’m not sure what the point of this post is.
How much would he pay to see Eric Clapton on any given day?
If it’s, say, $100, then you get $100 worth for $0.
And that contrasts with $50 worth of seeing Bob Dylan at a cost of $40.
In the former case, your luck is $100 and in the latter case, your luck is $10.
Go see Eric Clapton and you’re better off $90…that’s your opportunity ‘benefit.’
Another missing piece of the question (that should have caused all economists to balk at answering it): “Do I have $40 to spend on a Dylan ticket?” The money I would spend if I had it is different from the amount of money that is in my pocket.
Let’s use another example. Suppose you have three choices weekend trip to New York, a weekend trip to Chicago and a weekend trip to LA. Suppose the value of those trips for you, measured in dollars and given your own personal preferences, is $1500, $1000 and $500 respectively. (To say you value the NYC trip at $1500 means that if someone offers you a choice between a free trip to NYC or some money, you will take the money if the money offer is greater than $1500, and take the trip if the money offer is less than $1500.)
Now suppose the prices you would actually have to pay to take those trips – travel, hotel and expenses combined – is $1000, $750 and $1000 respectively. Then what are the net values of the trips:
New York: $1500 – $1000 = +$500
Chicago: $1000 – $750 = +$250
Los Angeles: $500 – $1000 = -$500
So New York comes out as the best option. Now according to the standard definition the New York trip has an opportunity cost of $250, because $250 is the net value of your next best option – Chicago. Great. But it is a meaningless quantity. In a decision situation with three or more alternatives, there is no reason for placing special emphasis on one specific next-best alternative.
Plus, calling this quantity “opportunity cost” creates the misleading impression that going to New York carries some additional cost beyond the $1000 you had to pay to go there. I’m not surprised economists stopped paying attention to this idleness. It is surprising that it is sometimes still taught.
The authors quote an introductory textbook on opportunity cost:
“In their introductory textbook, Case and Fair (2001) write that, “[a] good way to introduce economics is to review three of its most fundamental concepts: opportunity cost, marginalism, and efficient markets. If your study of economics is successful, you will use these concepts every day in making decisions.”
I do not know any rational person who uses the concept of opportunity cost to make decisions.
There is the intellectual construct in which the question is asked and then there is reality. We all know that modern economics is not a description of reality, rigorous or otherwise, and is not meant to be. It is propaganda to enable looting and intellectual masturbation and obfuscation to direct attention away from the looting.
Propaganda is all about making things seem reasonable that aren’t. Take “utility”. We all have some vague notion of what it is and can even come up how we quantified it in specific instances. But there is no way to define it with any precision or codify how it can be quantified or even relate it to the majority of our life and choices, even the so-called economic ones.
Dan Kervick mentioned upthread that there are more sophisticated cost-benefit approaches out there. But this doesn’t really change anything. It just moves it to a different level. What is a cost, or a benefit? A cost for whom? A benefit for whom? If I can rob a bank and get away with it or build a factory where I can pollute and pay poor wages, my benefit vastly outweighs the costs to me, even though the costs to others may be vast. In this regard we talk about “externalities”, but aren’t these just the social costs, and isn’t it the job of modern economics to ignore and/or down play these costs.
We need to recognize that not everything can be precisely defined or quantified. And we need too to see that costs and benefits however imprecisely defined and measured are a balance between the social and the private.
They can’t be precisely quantified. But if an official has to make a recommendation about how to spend some appropriated public money, they have to do the best they can to justify their decision in some way other than what just feels best. Sometimes when you try to put numbers on choices and outcomes, you find that while there is an unavoidably subjective element, your values are more determinate than they seem initially.
In other words, they set up a proxy which may or may not be applicable, so they feel good about their decision. But this determinative process must have parameters and if social conscience and consciousness are not included in them, then the process is nothing more than a sham. These are routinely excluded so we are left with shams.
Most propositions offered by “economics” is no more than superstition passed off as theory. The distinction between theory and superstition, of course, is that theory can be falsified by objective facts whereas mere superstition cannot.
After Bastiat, nothing.