The concept of opportunity cost “The opportunity cost of anything of value is what you must give up so that you can have it.” is the central theme of my book Economics in Two Lessons, due out in the US on 19 April and hopefully in Australia soon after that. My central claim is that two lessons based on opportunity cost and their relationship to market prices provide a framework within which almost any problem in economic policy can usefully be considered.
That’s not the way economics is usually taught (opportunity cost gets a brief nod before the focus moves on to supply and demand). So, I was impressed to see Bill Shorten use the term in relation to climate change inaction. Not only that but he used it correctly! Here’s Bill, quoted in the SMH
Opposition Leader Bill Shorten defended the new policy by urging voters to consider the cost of inaction on climate change, saying “There is a huge opportunity cost when we don’t take action,”
Perhaps I shouldn’t be surprised. Labor’s Shadow Assistant Treasurer is Andrew Leigh, a fine economist who has had nice things to say about my book. And Labor has been listening to Richard Holden, who is, I think, the brightest young economist we have right now.
Surprising or not, it’s great to see a return of economic literacy to public debate, after years dominated by vapid slogans.
John Quiggin 
Should we consider the concept of opportunity cost in light of the government’s decision to close down the Xmas Island facility after wasting nearly 200 million trying to get it open again? Downstream costs that would have followed?
How would this decison stack up against a proposal to fund health to save on the need to fund when conditions may be worse, negating the ability to just spin away from responsibility because things have become visible. or something to the CSIRO concerning the elimination of introduced, environmentally destructive pests (Anning?).
It would be worthwhile to spell out what the opportunity cost of not taking stronger action to address climate change is: The environmental cost of more emissions and presumably moral suasion impacts related to our ability to influence other countries to take action. From these costs there needs to be deducted the costs avoided in not taking extra action – the costs of expanding our electricity sector using renewables so that half of all vehicles sold can be electric powered by 2030 etc. Bill has not been forthcoming on the magnitude of any of these cost components and several have questioned whether he has any idea.
The electric vehicle forecast is way out-of-line with industry forecasts so some more information would be useful.
I am interested in the latest theory on the chronic low growth of western economies in the past 10 years. Secular stagnation has been thrown up to explain the cause, too much wealth locked away in the savings of big corporations and wealthy individuals with too few opportunities for productive investment. This all makes sense to me, too much wealth in corporate hands and a few individuals who often don’t pay their fair share of tax and spend money to fight any policy that might open up markets to competitors that then would introduce new players and new jobs and investment.
What apalls me is that in this era of economic stagnation we are staring at a literal tidal wave of potential investment in environmental rehabilitation worth billions, if only we agree that the environment is important. Renewables, solar, wind, electric cars, hydrogen gas for a start. Let’s call time on traditional farming in western Queensland and NSW and pay farmers to stay on their land but destock and rehabilitate their land to its original state while managing feral animals and noxious weeds.
Is this vision to rehabilitate our natural environment so hard to sell?
“Surprising or not, it’s great to see a return of economic literacy to public debate, after years dominated by vapid slogans.” – J.Q.
Look, I agree that Shorten’s position is better than the LNP’s, meaning it will turn out to be marginally better for people and the environment in real outcome terms though almost certainly not radically better. We are in such a perilous position now that radically better, radically soon, is what is required. The problem with mainstream economics goes all the way to its foundations. I will ask the leading question. Is mainstream economics in any of its classical or modern derivative forms really “literate” in the sense of being both logically and empirically defensible?
I refer people to this paper:
“Deductivism – the fundamental flaw of mainstream economics” – Lars Pålsson Syll.
Click to access Syll174.pdf
I really do think people (on this blog at least) need to read such a paper, absorb it and then come back and talk about “economic literacy” or perhaps more to the point about philosophical and scientific literacy. Is mainstream economics philosophically and scientific literate? Clearly, on the back of papers like this (and there are many) mainstream economics is not. There is a wide range of heterodox criticism (some with its own philosophical and scientific faults for sure) which now seriously questions mainstream economics and its foundational assumptions. These questions are gaining more and more weight from scientific and philosophical progress, especially in the fields of complex systems science and systems philosophy.
In the light of burgeoning problems like increasing inequality, increasing trends to oligopoly and monopoly, increasing problems with the role of financial capital and especially an increasing likelihood of impending collision with real limits and/or serious to catastrophic biosphere collapse, it would seem that any prescription of more of the same mainstream economics (in any variant) is an ill-advised strategy. The paradigm which delivered these imminent catastrophic problems can only provide more of the same and thus exacerbate them not, solve them.
I have often thought that the concept of opportunity cost was one of economics true contributions to the world.
I would have preferred it if Bill Shorten had said, “The scientific predictions show we face a very high risk of damage and enormous costs if we do nothing about climate change.” Framing it as an opportunity cost serves little purpose. First, on at least one test occasion, even economists could not get a formal (money) opportunity cost problem correct. Second, ordinary people have even less idea what opportunity cost means. Third, the formal (economic) framing and calculation of opportunity cost soon leads to absurdities.
I can see a basic validity to opportunity cost reasoning when it involves only two real (not money denominated), closely equatable, simultaneous or nearly simultaneous alternatives unaffected by significant uncertainty.
If Band X and Band Y are playing on the same night at the same time, a person can see one band only at the cost of not seeing the other. Even then, calculation of opportunity cost really depends on framing. A student vacillating between choosing Band A and Band B perhaps should be studying for his important exam tomorrow. Perhaps that is “the highest value option forgone”, the real opportunity cost. The student might think he can squeak through without a last minute cram. He might be wrong. The cost of that cost (failing the exam), a knock-on cost, won’t be realized until much later with say the need to repeat that subject. Opportunity cost calculations typically fail to allow for knock-on costs.
In other words, as soon as the “closely equatable” and “near simultaneous” conditions are not met and the no knock-on cost condition is not met, the validity of opportunity cost reasoning becomes tenuous. It can often involve comparing apples with oranges and also have its calculations distorted by uncertain real event(s) after the calculation event.
Then, of course, mainstream economics comes along with money and makes money calculations to equate apples and oranges and uses discounting to deal with time. The first fallacy occurs when apples and oranges are compared in money as a counter for “utils”, the amount of “utility” or use value the person may get out of each item. “Utils” are a hypothetical unit. There is no real “util”.
The market is the heuristic instrument which decides the relative money values of each item. It is an heuristic instrument working off revealed preferences. Human preferences are not objective calculations in the main, at least not at the level of personal preferences and consumer goods. They are heuristic attempts to personally satisfice needs and wants by choices highly influenced by sense experiences and emotions.
The market, which is to do with satisficing now for consumers or in the next quarterly report for small business (or even in the next 5 year corporate plan) does not, in the main, reflect plans for the longer term nor make proper assessments of all long term costs. Fiddling with the discount rate can make huge changes to what future opportunity costs are calculated. Hence, money is a poor measuring stick. It’s unit (“utils”) is highly unstable, unreliable and in its machinations riggable. Many, perhaps most prices in capitalism are rigged in one way or another; dishonesty, insider trading, cartel behavior, oligopoly, monopsony, price setting, business sabotage (in the Veblenian sense), industrial sabotage, war, sanctions, trade-wars and so on.
The uncertainty of money under this weight of problems renders the logic of opportunity cost calculations, in money, null and void.
I am confused JQ, much as I agree with Shorten here it doesn’t seem the word “opportunity” adds anything to his statement?
I suppose every cost can somehow be framed as an “opportunity cost” but it doesn’t seem a natural framing in this case
But does Shorten get opportunity cost right? The OP says “The opportunity cost of anything of value is what you must give up so that you can have it.” The endorsement of Shorten’s statement, “There is a huge opportunity cost when we don’t take action,” implies that there is only one policy that can combat climate change and that is Labor’s policy. But there are many possible climate change policy. The Government has a climate change policy. You can say that it’s not good enough, but it’s something. And another alternative to Labor’s policy is the Greens’ policy, which is to take stronger action.
“The opportunity cost of anything of value is what you must give up so that you can have it.”
We’ll hear tonight whether the opportunity cost of integrity is too high for Shorten to fully criticise and frankly call out all LNP Budget deceptions, counting tricks, and shared fantasies. We’ll be able to hear whether his integrity is valued more than an opportunity to be of service to the governing quadropoly party migration profiteering one-per-center donors and post politics career patrons of consequence.
In 48 hours so far we haven’t heard a peep anywhere from Shorten’s faux opposition about the truly staggering blow out in NOM numbers forecast for the next few years as contained in budget papers. Migration numbers are not gonna be capped at 160,000 per recent LNP posturing, but the forward estimates actually show NOM rising from a current ABS reported 240,000 to 271,300 by 2020.
https://www.macrobusiness.com.au/2019/04/budget-exposes-coalitions-fake-immigration-cut/
Good-bye all environmental hope. Sold out, sold off, yet again it is as usual the _hardly normal_ styled ‘integrity’ showing through the veneer of representative democratic government stewardship.
Please read the post by Ikonoclast very carefully. I think he has explained things pretty well.
“There is a huge opportunity cost when we don’t take action,”
I think that politicians already use/misuse economic terms/concepts sufficiently. There are so many things these models/quantities don’t take into account (not even mentioning that they are just ‘models’ that often have theoretical value only, are not deterministic, easy to misuse/use to one’s own advantage, etc). And so many valuable things to which they assign the constant value of zero. For example taking care of the environment. In part thanks to these we cannot talk directly about taking care of the environment, but must justify ieverythinh in terms of profit. It seems to me that the economists are partly to blame, for not producing better models, among other things (I am not an expert and this is only an impression. I am not comparing economics with other fields either).
Listening to Andrew Leigh speek about economics is however a pleasure.
@AleD
It is an “alternative fact” to claim that economics places zero value on the environment. Nonetheless, as Google Scholar and science journal websites only list several million economic studies that do just that, I can hardly blame you for not noticing.
@Hugo I did not say that there are no studies on this. I was thinking of things suvh as GDP, which is the most interesting thing to a politician, and which takes no account of things such as women’s work (you being a champion of women’s issue could take this up with the economists and politicians) or environmental demage.
Hugo,
What is the main concern to these economists studying the issue? (Please note, this is a question, not an attack)
And please Hugo, frame your comments in a less sarcastic (nicer way) if you are addressing my comments. I don’t claim to know much and don’t therefore deserve attacks.
By women’s work, I obviously mean the unpaid work done by women at home (child raising, cooking, cleaning, shopping, etc)
This work has an associated opportunity cost that is not recognised nor talked about, and affects half of the population.
You can see this last comment as an “alternative fact” if you wish.
John, Looking forward to reading your new book. I am sure it will be an interesting read. In addition, I must have a look at Richard’s work at the McKell Institute. I guess I have been a bit sceptical of what that institute has been doing since they invited Lawrence Summers there to do a talk last year. Summers in my view was one of the architects of the pre and post GFC fiasco inflicted on ordinary Americans.
Seems to me that there is a failure in economics to take into account the opportunity cost for women of pregnancy and giving birth; there are significant ongoing costs for a woman’s heath and well-being from being pregnant and giving birth is always potentially dangerous.
How does economics value that sort of specialist work and/or a newborn baby? What is the opportunity cost for society of a baby or no babies?
Julie Thomas,
Your statement would also be accurate if simply truncated and reworded as follows. “There is a comprehensive failure in mainstream economics.”
However, I don’t want to minimize your main point. It is absolutely and centrally true. Sexism (and then orthodox economics) need to be abolished, first in all institutionalized forms and then in their ideational form as the mutually reinforcing False Logic – Hypocrisy – Authoritarian “triactor” ideological complex employed by the ruling patriarchal oligarchy.
Ikon I agree with you about the main statement but the issue of who pays for the future citizens could be the one that brings it home to half the population anyway that patriarchal economics fails at the very beginning to account not only for human nature but for human biology.
I assume Shorten used the idea of “opportunity cost” to point in the direction of adverse consequences of not dealing with the climate to the extent he advocates. It is a throwaway line.
My reading of the science indicates to me that what H.C. advocates, as per his economic prescriptions for Australian coal and if reflected by other international coal players, will lead to dangerous climate change of over 2 degrees C, with a high degree of certainty. Indeed, it will probably lead to 3 to 5 degrees of C warming by as early as 2100. However, I admit that the trajectory H.C. advocates is the one most likely to occur in our extant global political economy system. In other words, we are most probably doomed by the blind and unscientific ideology of mainstream economics and the fact that most people still believe the false axioms and deductions of said economics.
Real scientists are terrified of recent empirical developments (these being faster and more serious than almost all model predictions) and admit to it in private conversations. The built-in momentum of our growth path and the various accelerating feed-backs already look near certain to take us into dangerous, if not catastrophic territory. Orthodox economists tend, with a few notable exceptions, to live in a magic-pudding land where real systems pose no limits on the economic system. It’s strange they think this way since the real economy is a real system embedded in the biosphere real system.
However, orthodox economics continues to hypothesize “saving” features of the system such as resources are effectively limitless, the economy can de-materialize and substitution possibilities are limitless. None of these are completely true in the absolute. It is true that some key resources like oxygen, sunlight and water are effectively ubiquitous on a global scale, though the latter two are effectively lacking in some regions. Other key resources definitely are limited including the climate and ocean systems’ ability to absorb anthropogenic CO2 emission without major climate disruption. The economy can only dematerialise in very limited part and all of that effect and more is eaten up by the Jevon’s Paradox or Effect. It’s not a paradox but a guaranteed effect under growth capitalism settings. Finally, substitution effects are real but not limitless.
Orthodox economists fail to think scientifically, when doing economics, even when they are otherwise scientifically literate. The reason is that orthodox economics is a dogma. Those educated in the dogma are intellectually invested in it and blind to the falsity of their own axiomatic-deductivist system.
https://rwer.wordpress.com/2019/04/04/economics-becomes-more-precise-and-rigorous-and-totally-useless/#more-34389
It’s worth following the link to Philip Mirowski’s article (Part 1 of it anyway.) Ignore the introduction by another writer, which introduction really illuminates nothing that Mirowski explains much better.
Of course, all the orthodox economists here will most likely dismiss such heterodox ideas as crank objections to the one true and received doctrine of orthodox economics. Really, such persons are in the position of the Church elders when they opposed Galileo and the Prussian scientific establishment (parts of it at least) when they opposed Einstein’s theories of relativity. On the wrong side of history and science.
Still it moves! History moves. Science moves. The search for truth moves on… and some (many in fact) are getting badly left behind in this intellectual progress. They need to reexamine their axiomatic a priori assumptions. Axiomatic philosophical and logical errors, along with an un-empirical orientation, are problems not limited to Austrian Economics. In a slightly different form, they are the founding errors of classical economics and all the schools which depend on it.
I also noticed Bill Shorten having used the term ‘opportunity cost’ and, given the indicators in his speech as to policy direction on climate change, he used the term roughly correct in relation to scientific knowledge.
The difficulty with the notion of opportunity cost is that unless markets are complete, there does not exist a measure of costs for the alternative, which accountants would recognise now (there is no invoice). That is, with incomplete markets it is expectations and therefore appropriately defined preferences which determine the opportunity costs. Except for the uninteresting case of a society consisting of 1 person, there is no unique opportunity cost and therefore no agreement can be assured. This is the reason why I have no use for the notion of opportunity cost. I prefer to approach environmental issues from the perspective of a Lindahl equilibrium framework. However, the term opportunity cost may well be an effective communication tool in a policy context.
As expected in his budget reply speech Shorten failed to expose the LNP’s biggest budget stretch, biggest arithmetic sleight of hand, their biggest lie – ponzi migration; which also puts the lie to most anything Shorten proposed. Such reliability, never an opportunity wasted to duck or conceal the cost of the reigning oligarchy.
– If you repeat a lie often enough, people will believe it, and you will even come to believe it yourself.
-The best propaganda is that which, as it were, works invisibly, penetrates the whole of life without the public having any knowledge of the propagandistic initiative.
-Peoples do never govern themselves. That lunacy was concocted by liberalism. Behind its “people’s sovereignty” the slyest cheaters are hiding, who don’t want to be recognized. – Joseph Goebbels
Ernestine Gross,
Can I suggest you read this very interesting short paper?
“The Aggregation Problem : Implications for Ecological Economics” – Blair Fix
Click to access 20180500_fix_the_aggregation_problem_wpcasp.pdf
As further grounding, if you have the time, read this book:
“Capital as Power. A Study of Order and Creorder” – Shimshon Bichler and Jonathan Nitzan.
The authors suggest the book should be read in full and the reader should not skip ahead to the second section on their actual theory. However, if you already have a knowledge of classical economics and even a smattering of knowledge about Marxism, I think the first section can be skipped.
The theory does require one to look at modern capitalist economics from another angle, not a classical angle and not a Marxist angle.
Beyond snarky Hugo and zero on “siscussion”.
JQ apologies yet In the sprit of “isegoria[5] (equal right to address the political assemblies), ” Hugo’s comment passes but not here yet “isokratia[7] (equality of power) I have to stand up. “or on other commenters (flames) will be deleted, or edited to remove such points. Commenters with a repeated history of provocation (trolls) will be banned.” johnquiggin com/ discussion-policy/
I am AleD – no quotes – I think that politicians already use/misuse economic terms/concepts sufficiently. There are so many things these models/quantities don’t take into account (not even mentioning that they are just ‘models’ that often have theoretical value only, are not deterministic, easy to misuse/use to one’s own advantage, etc). And so many valuable things to which they assign the constant value of zero. For example taking care of the environment. In part thanks to these we cannot talk directly about taking care of the environment, but must justify ieverythinh in terms of profit. It seems to me that the economists are partly to blame, for not producing better models, among other things (I am not an expert and this is only an impression. I am not comparing economics with other fields either).
Hugo, I am standing up and calling you out as 1.5 – below “Paul Graham’s Hierarchy of Disagreement lists ad hominem as the second lowest type of argument in a disagreement.”
‘Discussion’!
Ikon at APRIL 4, 2019 AT 7:19 AM – excellent comment. 6.5 on the 7 point “Paul Graham’s Hierarchy of Disagreement”.
Thanks to totaram for getting me to reread your comment Ikon.
“The uncertainty of money under this weight of problems renders the logic of opportunity cost calculations, in money, null and void.” My model though Ikon – as null point errors are a deal breaker – must include opportunity cost always imo.
Ikon @ 6 April 2019, 9:04 AM,
The paper by Blair Fix is very readable. I have only one comment to make. IMO, Fix isn’t quite clear in relation to mathematics in economics. The issue of ‘unit of analysis’ and how it affects measurement is certainly not new nor is the issue of aggregation. Regarding the former, the issues regarding GDP, real or nominal are familiar to fully trained economists; I have given an example regarding opportunity costs. Regarding the latter, aggregation was the topic of a seminar I had the opportunity to attend at the University of Bonn in 1990. The presenters of papers as well as the discussants were all mathematical economists (Gerard Debreu, Beth Allen, Werner Hildenbrand were among them). While the word epistemology is not typically used in the work by these people, it is of course the usage of the language of (pure) mathematics, which enables theoreticians to deal with epistemological questions. Incidentally, Blair Fix also used mathematical reasoning to make his point clear and succinct..
JQ’s critical post of an article on the average income is an example of the misuse of statistical measurements.
I imagine Blair Fix’s paper would be most useful for teaching purposes, particularly in macro-economics.
(As an aside, I did find your link to a relevant paper on the global financial system. Yes it supported what I was talking about.)
Ernestine,
The other paper I linked to, was it this one? I’ve done a few links recently.
“The Autocatalytic Sprawl of Pseudorational Mastery” (version 0.12) – Ulf Martin
Click to access 20180600_martin_the_autocatalytic_sprawl_of_psudorational_mastery_v012.pdf