Opportunity cost

I received a letter from an old friend who asked:

I have a friend who is a writer and artist. One of his current projects is a novel. At one point he needs to explain opportunity cost. It recalled for me that you wrote a book for kids explaining the fundamental principles of economics.

Would be willing to share the text with us?

This was my reply.

I would of course be willing to share my text with you. The title is Economics for Infants.

However, not sure you find opportunity cost discussed, at least not explicitly. However, there is always this you can look at (it can be ordered by the library and the paperback is pretty cheap): 
 

Free Market Economics, Third Edition. An Introduction for the General Reader

The Elgar webpage is  here. And I do notice that Opportunity Cost is discussed on four separate occasions within the book, once even using a diagram. Highly recommended, if I do say so myself. In fact, I do say so myself.
 
I just put up a blog post referring to the book, which I will copy below. Here is what I said:
 

From The switch to green energy may be the biggest bonanza in history.

Australia is the best placed nation on earth to be the global winner in the net-zero world, with 672,000 jobs created and $2.1 trillion in economic activity generated by 2050.

In my economics text, Free Market Economics, the single most important chapter is the third, on Value Added. No other modern textbook that I know of actually discusses value added beyond a para or two, but without value added at the core of one’s grasp of economics, you will never understand a thing that matters.

Jobs can be created by getting rid of technology. Economic activity can be driven forward by useless and non-productive forms of “investment”.

But living standards can only rise if the value of output is greater than the value of the inputs used up. If you think massively increasing the cost of inputs through alternative forms of energy will increase value added, and therefore living standards, you are an economic incompetent.

Value added is the core concept surrounding opportunity cost, which also necessitates understanding the economic meaning of cost within economics. Which reminds me of this, which I may or may not ever have sent to you before: I, Mechanical Pencil: Why a socialist economy can never work.
 
There you find this, which is near enough the core concept of opportunity cost as it is practised in the market:
 
What prices must do is reflect how much something costs. And what information about costs does is help entrepreneurs work out which is the least costly way to produce whatever it is they produce. It is important to find the least costly way to produce because the fewer resources used up in making each particular good or service, the more resources are left over to produce something else. Keeping production costs down is essential to maintaining and building our prosperity. This is why prices matter so much. If prices are properly set in the market, the revenue received by each entrepreneur will cover all the costs of production. If every producer sets their own prices, then the prices charged for every input will provide the essential guidance to entrepreneurs on how to keep production costs down.
There I am. Give me an inch and I take the mile and then some. 

11 thoughts on “Opportunity cost”

  1. Would it be fair to say that the fact that Green energy (if it worked) would lead to fewer jobs is actually on of the benefits. If it worked, we’d be left with a more efficient energy system and a core of excess labour that could be better utilised.

    If.


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  2. “I have a friend who is a writer and an artist, and as such he has realized that he can get a long way in his field by simply reproducing content from third parties. If you are unaware of the writer’s device of irony, would you be willing to directly provide him with some of the content which you have produced, for free?”


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  3. Good work, Steve. And value, it must be recalled, is subjective value. Prices are objective value, the quantum of objective goods stated in terms of dollars or things, which are objective weights placed on those thinigs for calculation and exchange. As you correctly noted, but in different terms, entrepreneurs use objective, concrete inputs (e.g. capital goods and working capital) and objective, abstract inputs (e.g. ideas and intellectual property) as factors of production — each with their own objective costs — to produce outputs which they assess, guess, evaluate and weigh will be of more value for the client than the inputs. The consumer is the final judge: an exchange involves the transfer of his subjective value (e.g. a quantity of dollars) for the receipt of subjective value, in the form of some concrete good or abstract service. It is always an exchange of the lower for higher value.


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  4. Australia is the best placed nation on earth to be the global winner in the net-zero world, with 672,000 jobs created and $2.1 trillion in economic activity generated by 2050.

    this is the tell. No mention of how energy costs will be reduced, or how much extra output will be generated.

    Its a very expensive make-work scheme.


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  5. But living standards can only rise if the value of output is greater than the value of the inputs used up. If you think massively increasing the cost of inputs through alternative forms of energy will increase value added, and therefore living standards, you are an economic incompetent.

    Thanks, Steve. Alas, economic incompetents not only get the high-paying jobs these days, they also control public policy and both major political parties.

    Canberra always attracted the worst of us. It’s now spiv central for corrupt cronies getting rich off the government’s economic depravity.


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  6. I like your articles, Steve, but that was some “explanation”.
    You sure anyone not an economist would have any idea what you are trying to say? Talk about 1000 words when 10 would do.
    I took 1 minute on Google and came up with these 3 simple definitions, plus examples, that might have been more helpful to your friend? Though why he didn’t do the same bewilders me.

    1. Opportunity Cost refers to the loss of other alternatives when one alternative is chosen.
    “idle cash balances represent an opportunity cost in terms of lost interest”

    2. What is opportunity cost and example?
    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, for example, you spend time and money going to a movie, you cannot spend that time at home reading a book, and you can’t spend the money on something else.

    3. What is meant by opportunity cost?
    Opportunity cost is the forgone benefit that would have been derived by an option not chosen. To properly evaluate opportunity costs, the costs and benefits of every option available must be considered and weighed against the others.

    Don’t know if they are too simple for you as an academic but are they essentially correct?


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  7. Opportunity costs.

    You can demonstrate sunk costs easily.

    We use lead for sinkers fishing.
    Non corrosive, heavy for its volume and reasonably ‘soft”on the line.

    We could use gold to do the same thing, we would vastly increase our spending per fish caught but the industry would become much more “valuable”.

    And every sinker sunk would be a sunk cost.


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  8. Good luck Steve, I’ve been using this argument on people for years.
    And I’ve argued that another vital idea that is central to the west’s development; the fact we have always strove for efficiency and productivity, more for less, and that green energy trashes this fundamental.(anyone for nuclear?)
    Generally the reaction is that I’m the idiot because sunshine and wind are free! don’t you know?
    One argument I’ve gained a little traction with is to state that for less money than you we have spent on the green energy boondoggle we could have gone 100% gas and achieved a 25-30% reduction in gh gases in the area of electricity production. It has been funny to watch some panicked responses. I don’t actually know if this is true or not, but it must be pretty damned close.


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  9. Might be two or more views on what is opportunity cost here.

    If one applies the principle that an opportunity is going to cost x, then price has to be x+%, no?
    So, if opportunity or not opportunity, cost will be the same if sell price is immaterial, say for an item that a fucked in the head secretive govt decides is a necessity.

    If sell price is set by end users, opportunity or not cost becomes highly relevant.

    Fraulien, beer bitte?


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  10. Biggest issue we face – economically, at least – is the idea that demand drives the economy. It does not. Production does. We get “rich” by making and selling “stuff”, not by buying it – obviously.

    Take a look at the USA right now – demand is high, but production has tanked.
    The result?
    Inflation, stagflation, shortages of fuel , food and consumer goods, the “great resignation” and high unemployment at a time when there are 1.5 jobs for every (“officially”) unemployed person.
    And the Asterisk President ( *batteries not included), wants to spend US$3.5 TRILLION more, raise taxes, increase regulation and so on.
    We are no better – well, maybe a little, but not much. We are on the same path to destruction, our leaders slavishly following world’s best worst practice. So it’ll be a while before we catch up to the USA and the EU in that regard.

    Alas, this is unlikely to change any time soon – because Government can “create” demand by printing money and giving it away, but they can’t create production. Gov never creates anything, they only ever suck money out of the productive part of the economy, weather through taxation or regulation. And Gov always wants to “do something” to “fix” things that weren’t actually broken until they stuck their beak in anyway. The fix is always more of the same – the beatings will continue until moral improves.

    Poor fellow my country.
    moderated

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