Opportunity Cost and Tradeoffs

Course Outline

Opportunity Cost and Tradeoffs

Opportunity cost and tradeoffs are two fundamental concepts from economics and they are all around us. 

Tyler Cowen shares the definition of opportunity cost: the value of your next best alternative. Time, space, or resources used to achieve one goal can’t (usually) be used simultaneously to achieve another. A few examples of opportunity costs show that we face them all the time–even when we’re making decisions that don’t revolve around spending money. Some opportunity costs, like the value of spending time with loved ones, can’t easily be quantified in dollars and cents, so there’s no simple formula or calculator for opportunity cost.

Because resources are scarce, tradeoffs are everywhere. For example, building codes can require entrepreneurs to install sprinklers, safety glass, and other strategies to keep consumers safe. However, the cost of these building improvements can increase the costs of products and prevent new businesses from being opened. Economics can help you understand these tradeoffs so you can navigate them. Once you master the economic way of thinking, you’ll see these tradeoffs everywhere you look. 

Teacher Resources

Transcript

Once you master the economic way of thinking, you'll see the world in a very different way. Two fundamental economic concepts are everywhere you look: opportunity cost and tradeoffs.

Let's start with opportunity cost. At this busy coffee shop, opportunity costs lie behind every decision. Like for Jenny -- she's here for her third date with Adam. Was that a good decision? After all, economics is all about studying decisions. Making a good decision is about comparing the benefits of that decision to the costs. The obvious costs for this date, for Jenny, were the Uber ride she paid for to get here and her grande chai tea latte with whole milk.

But what's missing? Her opportunity cost. Opportunity cost means the value of the next best alternative. For instance, instead of going on her third date with Adam, Jenny could've been binge-watching her favorite TV show. She might have been on a first date instead, with Roman. Or she might have been having breakfast with her very sweet sister. Let's say her next best option would have been breakfast with her sister. Does the benefit of this third date with Adam outweigh the opportunity cost? It might seem strange to think this way about romance, and it doesn't mean that it's about calculating every decision down to the last penny. Nonetheless, Jenny's time, attention, and energy -- those are scarce. And if she doesn't consider the alternatives at all, she might be wasting parts of her life.

There's another fundamental related concept from economics: tradeoffs. Take these sprinklers in the ceiling of the coffee shop, for example. Adding sprinklers can make it safer during a fire, but they also can cost a lot of money to install. How much cheaper would the coffee be without them? In a world of scarce resources, one typically has to choose. There's a tradeoff -- safer buildings cost more, but that means the coffee can be more expensive.

Hmm, the line is at the door here. Perhaps the owner has considered opening a second location. As the building code, however, becomes more stringent, the cost of opening an additional location goes up. It's not just the direct monetary costs of paying for things like sprinklers; it's also the opportunity costs of the extra time and effort to file permits, manage the work, and schedule inspections. A more stringent building code means a higher cost for opening up new businesses. And in turn, that higher cost can mean that fewer new businesses get opened.

What's the right tradeoff between making buildings safer... and making it easier to launch new businesses? Once you see these tradeoffs, you'll find them everywhere you look: healthcare, food, the environment, education. One more decision to consider: if you're a teacher, should you spice up your economics class by checking out our free unit plan that uses this video? If you're a learner, should you watch another MRU video? Well, YouTube is full of entertaining videos, but please, of course, consider the opportunity costs.

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