Opportunity cost: A Fabian idea?

As part of the research for Economics in Two Lessons, I’m looking in to the history of some of the ideas I’m talking about, including Pareto optimality, externalities and of course opportunity cost. I’m undecided as to whether I’ll include this material, perhaps as starred (skip if you feel like it) sections, or in an Appendix. Suggestions on this point are welcome.

My research on the intellectual history of opportunity cost has so far gone no further than Wikipedia, which attributes the term to Friedrich von Wieser, an Austrian economist in both the national (he was Minister for Finance there in 1917) and theoretical senses. Turning to the article on von Wieser, I was surprised to read that he put forward an argument very similar to mine regarding the relationship between opportunity cost and the distribution of wealth

Instead of the things that would be more useful, there are things that pay better. The greater the difference in wealth, the more striking are the anomalies of production. The economy provides luxury to the capricious and greedy, while it is deaf to the needs of the miserable and poor. It is therefore the distribution of wealth that decides what will be produced, and leads to a consumer of a more anti-economic variety: a consumer wastes on unnecessary, guilty enjoyment that which could have served to heal the wounds of poverty. —Friedrich von Wieser, Der Wert Natürliche (The Natural Value), 1914.

It turns out, even more surprisingly to me, that von Wieser was linked to a Viennese group of Fabians.

I’m still trying to digest this, and work out where to go next with it. Can anyone point to useful information about von Wieser?

124 thoughts on “Opportunity cost: A Fabian idea?

  1. I have just re-found a quote of JQ’s that I remembered from earlier – a note to a previous post on why he used orthodox economic concepts

    “I guess the big exception to this [ie appropriateness or functionality of using orthodox concepts but in a critical way] is if you want to discard methodological individualism altogether, but the theoretical enterprises that took this route (such as structuralism) don’t seem to me to be prospering.”

    I found it on the CT site http://crookedtimber.org/2007/06/01/heterodoxy-is-not-my-doxy/ I guess it was probably on this one too?

    I think what I am talking about is discarding methodological individualism, though that’s probably not the way I’d express it – so I guess I may just be disappointed trying to have a discussion about it here, since JQ has apparently decided that critiques of methodological individualism are a side trail he doesn’t want to go down.

    However I’d say that in social theory there are a number of answers already being offered to the debate about structure and agency, including social practice theory and cultural theory drawing on Bourdieu et al. The issue to me is how do we incorporate ecological perspectives in this. However it looks like I’m in the wrong place to be having this discussion, which is a real shame.

  2. @Ikonoclast

    I said it was more a concept than a tool for a particular purpose. If I said that sustainability was more a concept than a tool for a particular purpose, would you respond ‘If a concept has no purpose why create it?’

    If you want to learn more, I suggest you start with something more elementary than the rank-dependent expected utility model. You’ll need to understand the modelling of preferences under certainty before grappling with uncertainty, and even then it’s best to start with basic expected utility theory because the rank-dependent model is a response to its shortcomings.

    @Ivor

    Not if they are acting in accordance with their preferences as described by you.

  3. @Luke Elford

    Fair point, an umbrella concept may well be very different from a dangling concept. I’d have to think it through and anyway reasoning by analogies has limits so I might get precisely nowhere.

  4. @Val

    I admit I find J.Q. too economically orthodox for my ideological biases. But his blog is the most owner-tolerant one I know. He tolerates more dissent, more heterodoxy, more disagreement and even more combativeness against his own views than I have seen elsewhere. He also allows user-generated comment threads (sandpits etc.) to go on their own merry way. He comments quite a bit and has interchanges with a diversity of bloggers. This makes it more interesting than many blogs. I like the blog-owner to be an active conductor but not a dictator.

    I don’t actually visit many blogs and I write almost exclusively on this blog so take the next comments as coming from a very small sample size. Only Gail the Actuary interacts more with her guest bloggers than J.Q. does. However, I am now critical of Gail’s entire approach to her subject matter and I don’t bother to write there anymore.

    Bill Mitchell’s MMT blog is very interesting. He provides enormous detail in the areas of macroeconomic hard data and policy around the world (well mainly Aus, USA, EU and Japan). His ideological bias also matches mine (very left wing) but he separates his ideological comments well from his MMT posts which definitely predominate. I have little trouble accepting his MMT perspective. I accept most of it apart from a few rather rhetorical (IMO) exaggerations. I fail to see how a Keynesian could have much trouble accepting MMT or significant swathes of it.

    OTOH, Bill’s blog is mostly an intense monologue pushing the same essential MMT principles over and over but always with new hard data. The focus goes deep into macroeconomics, national accounts and national macroeconomic policy (for a blog) but not wide into other parts of macroeconomics or other social issues (usually). Bill rarely interacts with guest bloggers though I did provoke him to write an essay-sized blog once refuting my claims that MMT was too much founded on ” growthism” which is in contradiction to limits to growth.

    His ripostes on that topic (LTG) are good and well nuanced as are J.Q.’s. One comes away feeling both that they are the most enlightened economists one has come across re LTG issues and yet somehow they still seem too “economy-ish” on the issue and not quite ecology-ish or physics-ish enough. It’s hard to put one’s finger on it but there seems somehow to be at base an enormous faith in economics (if faith is the right word). I am quite a bit more sceptical about economics and belong to the school of thought that the natural laws (of physics, chemistry, ecology etc) finally do hold all the trump cards.

    Voluntarism is the doctrine that the will is a fundamental or dominant factor in the individual and his/her life course. It is probably related to methodological individualism. Going up a step, we could say that a doctrine or spirit of societal or civilisational progress-voluntarism is the animating belief of much economics. Economists really believe for the most part (it seems) that humanity can plan for progress in everything or most things and not suffer too many unintended consequences. If economists do not exactly hold the view that man can “dictate” to nature and physical forces then at least they seem to presume man can negotiate on an equal footing.

    It’s as if economists don’t have a full acceptance that the economy as a system is a fully embedded sub-system in and dependent on the biosphere system (the system of natural systems). It’s more as if they see the economy as being on equal footing with nature and “yeah sure we can horse-trade successfully with nature anytime, anywhere, any century.” It’s this kind of intellectually insular hubris that troubles me. It’s like they don’t have the final level of respect for the ultimate level of wicked problems. Somehow their faith in their own systems is rather too great. It could do with being tinged with a little more humility and caution. It’s classical hubris. And we know or ought to know what regard the “gods” (really the natural forces) have for human self-importance. Of course this is just my idiosyncratic view and a very subjective one at that.

  5. Ikonoclast, I think an issue is with the use of “next best alternative”, instead of “best alternative forgone”, as they are not interchangeable: the former implies that my current choice is optimal, and therefore all other alternatives are of less value to me, but there is (at least one) alternative which is the “next best alternative”; the latter says that for my current choice (which could any of the options, even be the lowest value choice in my judgement), which mightn’t be optimal, I look for the highest value alternative among the options excluding the selected one, and it is quite possible that the “best alternative foregone” is of higher value to me than the option I did select.

    By the way, when I say “select”, I don’t mean I actually prefer that option selected: it is only selected in the hypothetical, meaning that to determine the opportunity cost if I select a particular option, I consider the best alternative forgone in the set of all options excluding the selected one.

    Again, I’m not an economist so you get wot you pay for in reading this 🙂

  6. Lets see whether a thorough treatment by JQ of the alledgedly fundamental concept of ‘opportunity cost’ can show results such as those by Varian (1974), “Equity, Envy, and Efficiency”, JET, 9, pp 63-91, to be special cases. Would it lead to fewer implementation problems than state contingent valuation models in the area of environmental economics? I look forward to the book.

  7. Johnston’s The Austrian Mind, a favorite book of my youth, has some sections on von Wieser, his teachers and students, and the overall intellectual and cultural background.

  8. @Donald Oats

    I’ve already written far too much on this thread and this had better be my last post on it. I’ve stated what I get about opportunity cost and what I don’t get about it. As much as I twist my logic (or lack of it), the concert ticket question seems illogical to me as does the answer to it. My mind rebels against it.

    I read the paper about applying the test to various economics graduates. The number of correct answers was no better than one would expect by chance on a multiple choice test. To me this is diagnostic of something but my diagnosis is different from that of the authors of the paper.

    If so many graduates performed so poorly (a statistically valid sample I assume?) then this could indicate one or more of the following as some possibilities are not mutually exclusive;

    (a) they had not been taught a key concept properly;
    (b) they had forgotten a key concept or how to apply it;
    (c) opportunity cost is not a key concept at all;
    (d) opportunity cost is a formal concept with little real application except perhaps in the case of opportunity costs in production (explicit and implicit costs) and thus rarely exercised;
    (e) the problem question poses such an unrealistic or hypothetical twist on the formal concept that it makes little practical logical sense and thus confuses people;
    (f) the problem question has a fundamental flaw in logic.

    The authors of the paper seemed to assume (with no real discussion that I can see) that the issue existed about in the area of (a) and (b).

    I tend to the view that the issue resides in the area of of (d), (e) and (f). Most of my previous posts are the best evidence I can muster for this view so I won’t repeat myself.

  9. It would be interesting to see a parallel experiment attempted in one of the physical or biological sciences: I mean, researchers could select a suitable problem dealing with a basic concept from an introductory textbook and then pose it as an impromptu test to attendees at a conference in the relevant field in order to see how they perform. Would they do better or worse than economists, or about the same?

  10. @Ernestine Gross

    Such a distribution described by Varian could only exist under communism or possibly in some form of stationary society such as:

    R A Radford’s economic organisation in POW camp
    Kibbutz/Armish settlement
    community on large passenger cruise ship
    military force

    It cannot exist under capitalism – because of the restricted nature of wage-labour.

  11. @Ivor

    I believe you misunderstand the reseach methodology of mainstream economics, as it developed during the second half of the 20th century. You are not the only one. The purpose of Varian’s article, as I understand it, is not to say “this is what we (or you should) want” (or “you can’t have unless you become a communist”, as you assert). In the first instance, this paper provides some conceptual definitions of words. For example, in the more recent past, the period during which wealth inequality has grown in many local economies, the word ‘envy’ has been introduced and used by those who gained a lot of wealth, relative to others, to justify their position on the grounds that complaints are merely an expression of ‘envy’. Varian provides a concept of envy which potentially is applicable to everybody in a society, including the currently ‘rich’. (‘You are only envious’ is not longer an argument’.) Then he relates this new concept (in economic theory) to Rawl’s theory of justice (philosophy) and then to well established notion of efficiency in economics. Finally, he analyses the model by checking under which conditions on the elements of the theoretical economy, stated conclusions make sense. The reader can then reflect on what insights are being gained, given empirical information on the state of contemporary society. (Too much is already known as to why the idealised form of communism – preferences are being communicated to a central planning agent together with complete information on resources far into the future – doesn’t work).

    May I suggest you read

    John Quiggin, “Heterodoxy is not my doxy”, referenced by Val @2, p2.

  12. @Ernestine Gross

    I don’t think that Varian was explicitly stating what we should want. he was setting up a model of distribution and definitions.

    However surely these only have interest and relevance if and only if they can lead to real social effects?

    You do not need a central planning agent to communicate preferences. This is a false cartoon.

    I read Quiggin’s piece but it was extremely naive and written in 2007 before the GFC. Contrary to Quiggin and the CT crowd – orthodox Marxism, when faced with the challenge of depression and fascism, did not produce nothing but the counsel to wait for the revolution.

    It produced an international war against fascism in Spain, many domestic struggles against Nazis in occupied zones, self management in Yugoslavia, Eurocommunism after the Second World War and immense social and worker movements across the Western world. Rosa Luxemburg did not counsel anyone to wait.

    you will find the “wait for the revolution” canard better associated with the ALP left and fence-sitters such as John Langmore etc.

    It produced the exact opposite to Quiggin and the CT lot who appear to all swoon after digesting rank fiction as in “Red Plenty” which they propagate.

    My comments were the result of (as you suggest)

    The reader can then reflect on what insights are being gained, given empirical information on the state of contemporary society.

    presumably that is what Varian wanted?

  13. @Ivor

    So. you pick on a date when you believe it serves your argument but you ignore the dates relevant to the article by Varian and my comment. Won’t wash, Ivor.

  14. @Ikonoclast
    A couple of other possibilities: the survey was poorly executed (but I doubt that’s the case); opportunity cost is easier to appreciate when applied in strict finance, i.e. value is easily understood in dollar terms, as opposed to the survey question (where value is a subjective conversion from enjoyment to dollar value for acquiring that enjoyment). No doubt there are more possibilities.

    One thing that’s curious is that the mid-range answers were chosen a bit more frequently than the two extreme answers. I don’t know if it is statistically significant, but it suggests the subjects fell foul of framing, i.e. they tended to select answers between the two extremes.

    As a pedagogical tool, it wouldn’t be a bad idea to test student knowledge in this manner at different points throughout the undergraduate degree, not to fail them or grade them, but to measure how well the fundamental concepts are being absorbed. The secondary benefit of a short survey is that the questions just might prompt a few students to re-read their notes on the fundamental definitions, concepts, and how they work. Then again, surf’s up.

  15. @Ivor

    Varian was published, as stated, in 1974 and I talk about research methodology in the second half of the 20th century and contemporary society. You bring empirical examples which date from the first half of the 20th century or earlier. As for motivation of authors, there is also curiosity.

  16. @Ernestine Gross

    The scenario suggested by Varian could not exist in both the first half or the second half of the 20th Century nor even in the first half or second half of the 21st century because wage labour, by definition, creates an unfair distribution and therefore continuously generates “legitimate” envy.

  17. @Ivor

    I acknowledge your opinion on whatever.

    I look forward to see what JQ comes up with using ‘opportunity costs’. I have never considered the notion of ‘opportunity costs’ as fundamental but I am curious. Who knows, something interesting and useful may evolve.

  18. Confusion arises because discussions of opportunity cost often define it carelessly as ‘the value’ of the forgone alternative.

    What they mean is, ‘the NET value TO YOU’ of the forgone alternative. This is the ‘consumer surplus’ – the difference between the amount you would be willing to pay for the forgone alternative and its actual price.

    If you would be willing to pay $50 to see Dylan, and Dylan costs $40, seeing Dylan gives you a consumer surplus worth $10. [note 1] If you miss Dylan, for whatever reason, you have forgone that $10 worth of consumer surplus.

    How much you value seeing Clapton will of course influence your choice whether to see Clapton or Dylan, but it’s irrelevant to answering the question ‘What is the opportunity cost of seeing Clapton?’

    We’re talking here about the conventional definition of ‘opportunity cost.’ *By that definition*, it’s quite clear that the answer is $10. Whether you think that’s interesting or psychologically realistic or relevant to real world problems is a different matter.

    I have no trouble accepting that the concept of opportunity cost is relevant to real world problems. If I drop into a church fete with $20 in my pocket, and see two things that I covet, priced such that I can only take one of them, I will definitely be thinking about opportunity cost.

    #70 Ikonoclast: if you define the forgone alternative as ‘a different icecream’, the opportunity cost of choosing icecream A is whatever your consumer surplus would be if you chose icecream B. If you define the forgone alternative as ‘a different icecream plus a lolly’ the opportunity cost of choosing icecream A is whatever your consumer surplus would be if you chose (icecream B+lolly).

    Note 1: if we accept the conventional practice of using money as the common unit for comparing the value of things of different types. In this case the things being compared are the pleasure of seeing Dylan versus the utility of having $40 still available to be spent on other things.

  19. Joseph Stiglitz’s latest talk on “Inequality” is on the ABC Big Ideas website.

    http://www.abc.net.au/tv/bigideas/stories/2014/07/30/4057169.htm

    I have gagged myself from talking more on opportunity cost on this thread. (Everyone can breath a sigh of relief). However, a number of posts above began to branch into other interesting arenas. Maybe when we get a new Monday comments and new Sandpit we can discuss some of these issues.

    Certainly growing inequality is becoming a big issue. The right way(s) to tackle this problem need to be debated in our community. Another issue is the prediction by some economists that Australia is heading towards a recession. Connected to this is the issue that current macroeconomic settings do not seem stimulatory enough, or at all, to some economic observers, to do anything to prevent this slide into recession. Finally, there is a question, in my mind, about working within the orthodoxy or questioning the orthodoxy fundamentally. In everyday speak do we need to reform the existing system in some direction or do we need to completely transform the system into something new? But as I said, these are topics for the sandpit.

  20. @John

    If the definition of opportunity costs is net value then the answer is $10.

    However I have seen opportunity costs derived as the slope of the production possibilities frontier (which, it appears, is not “net”).

    There are also concepts such as “social opportunity costs” – which are not net.

    A definition of opportunity costs as “net” is not useful if you get the same net benefit from transacting a million dollars as a hundred dollars.

    Investors would look to net – percentage benefits.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s