By Tony Samson
PAUL SAMUELSON, Nobel laureate in Economics, and the author of the basic textbook, Economics (first published in 1948 with at least 19 editions since then) which we used when I was taking up the course in college, explained economics simply as the allocation of scarce resources, using the famous two choices of guns and butter and the trade-off this process implies.
Behavioral economists too define the dismal science as one about making choices, introducing only emotions and imperfect information.
The consumer is always confronted with choices — lease or own, stocks or bonds, acquire or partner, produce or outsource, create or curate content, and the various permutations of combo meals.
The concept of “opportunity cost” puts a value on the discarded option. It deals with the quantified benefit that is lost in making a specific choice, the next best alternative foregone along with its present and future consequences.
The choices can be purely economic, as in taking early retirement at age 50 and getting a lump sum exit pay, especially if enhanced. The discarded option then is to continue working until mandatory retirement and the cost of foregone future payroll, bonuses, and health care coverage.
As in all economic theories, certain assumptions are implied in this not-so-theoretical choice of working or retiring. Is this a voluntary choice where either option can be realistically selected? Maybe, the operative theory is not opportunity cost but making the best of an inevitable situation, or what non-economists call, “putting lipstick on a pig.” Yes, it still farts.
And are choices reversible? If one opts to retire, can he six months afterwards decide to work again and make retirement the discarded option whose opportunity cost consists of unread books that must be written off and trips that can no longer be taken.
Choices are seldom equally accessible. Few, for example, are offered the choice between being a brain surgeon or a concert tenor. Opportunity cost is irrelevant when we are not eligible for either alternative due to a lack of talent or brains.
One TV program starkly illustrates the concept of opportunity cost. Choosing which briefcase to open is not much of an analytical process, except where one of the attaché girls is so fetching that she is left for last. Here is a perfect example of opportunity cost. Choosing among fewer and fewer briefcases provides instant feedback on the wisdom (or folly) in picking which to open. In the final selection between the previously selected case and the last one left on stage, the banker offers a known quantity to match against an unknown one. The host makes sure the contestant finds out the amount (and opportunity cost) of the lost option which can cause either jubilation or misery.
Choices too are seldom static. The relative values of two options may change with time as the foregone benefit becomes blurred. In selecting a life partner among eligible mates, the more desirable target may make her own selection — the handsomer one. The consolation prize one settles for may turn out to be the bigger prize when the original choice eventually becomes a weight lifter, at a circus. The cost of a foregone option seldom stays constant and can therefore be hard to quantify.
Once a choice is made, it is unproductive to look back and make calculations on the second choice. The unpicked choice ceases to exist and should no longer figure in any rational discussion except in hindsight. Is it useful to cry over and compute the price of spilled milk?
Robert Frost in 1916 wrote “The Road Not Taken.” He was not thinking of opportunity cost. It is not too fanciful to surmise that poetry here gave birth to an economic concept. The first lines introduce the economic dilemma: “Two roads diverged in a yellow wood/ and sorry I could not travel both/ and be one traveler…” Frost too understood the dynamics of taking one particular option — “knowing how way leads on to way/I doubted if I should ever come back.”
Elections too are about choices being made. Picking 12 (or eight) out of 76 names, not counting the 70 considered nuisances, and one who withdrew for health reasons means leaving out the rest. It is not certain what the costs (or benefits) are even after the terms of the declared winners end…and a new set takes their place. Some costs cannot be quantified even by economists.
Tony Samson is Chairman and CEO, TOUCH xda