Montreal, August 15, 2012 • No 302

 

François-René Rideau is a French cybernetician now living in the US. He owns Bastiat.org and Liberty, as it is and writes on Cybernethics.
 

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Economics Lesson #1 - Opportunity Cost

 

by François-René Rideau
 

          "You can't have your cake and eat it, too." This popular saying is often used to remind people of the one central principle behind all economics, the idea of opportunity cost, showing how well entrenched it is in common sense: any given resource (in this proverbial case, a cake) may be put to some use or other, but it is consumed or immobilized in the process, excluding all alternative uses.

 

          And yet, I never realized how the literal meaning of this saying is inappropriate as an illustration of the abstract principle it is purported to illustrate. Have my cake? What for? The entire purpose of a cake is to be eaten. Now or later, is the only question. Maybe I'm sated right now, and I can't eat it; but trust me, I will, as soon as I have space in my stomach. Maybe I want to eat it later with someone I love, to create a magic moment after dinner. But in the meantime, if anything, the having of it is a liability, not an asset: the cake may melt or go stale, oxidize, ferment or rot, it may be dropped, squished, sat on, forgotten, lost, stolen or eaten by someone else; I may have to carry it carefully wherever I go, or make a detour to store it in the fridge and then fetch it again later.

          Really, who wants to have a cake? Even the baker is all too eager to find someone to sell it to, someone who will want it for the eating. If you offer it to a friend, you won't expect your friend to frame it, but to eat it. Finally, I don't know about you, but when I was a kid, the best way to have another slice of cake was to promptly finish the current one; there was no extra cake as long as my plate wasn't emptied, and if I took too long to finish it, there might be no cake left for an extra slice as others may have eaten it all.

          But perhaps, after all, these are also important points to be made about opportunity cost, and the saying can remind us of these points as well as of the main concept.

          What economists call economic cost, or opportunity cost, is what you have to forsake when you make a choice; and they call benefit what you gain from an opportunity that you wouldn't have gotten from other opportunities to use the same resources. For whichever way you look at things (and ultimately, which way you do look at things is indeed your own choice and responsibility, with its own costs and benefits), the available opportunities are never equal to each other (otherwise, there's only one opportunity and no real choice). Some opportunities are obviously better (eating the cake, sooner than later), as compared to other opportunities that are obviously worse (hoarding the cake until it goes bad).

          Of course, "better" or "worse" only make sense as part of such a comparison between opportunities; it is always relative to the interests, goals and values of whichever individual is making the choice; and it is always done according to his limited knowledge of a specific context. (Don't eat the poisoned cake... unless it's an elaborate suicide; but maybe you didn't know it was poisoned.)

          When you are offered a new opportunity, it only matters if this opportunity is better than the one you would otherwise have gone for, at which point its benefit is the increase in enjoyment: "Will you trade your cake for mine? Well, sure, that way we can each enjoy a cake we like better." That's a mutual benefit considering how much you and I, with our different tastes, prefer our new cakes to the old ones. Or "No, thanks" — maybe you'd prefer my cake to yours, but so do I, and so this opportunity is of no benefit to me.

          Similarly, when denied an existing opportunity, it only matters if this was the previous best opportunity, at which point the cost of this denial is to have to cope with the next best alternative. "Oh no, the sauce you poured on your cake contains almonds, but you're allergic to almonds!" Well, now you must do without eating your cake; hopefully you can find someone with whom to trade it.

          Of course, it might not always be clear which opportunity is best. You're offered to choose one of many desserts. The chocolate cake is hard to get wrong, but most pastry chefs only do it so well; the crême brûlée can be anything from overly sweet, creamy and gross to beyond perfect with subtle fruit flavours; you know you'll love the passion fruit mousse, but what about that delicious sounding novelty you've never tried? Some of these opportunities may be pretty safe bets, while some are definitely riskier ones, but with a potential higher payoff (introducing you to new ingredients that you'll love in the future).
 

"Life isn't about making the best out of one choice regarding one indivisible resource, but a continuous series of choices in the context of an evolving pool of heterogeneous resources, of which you may allocate parts to various present and future uses, and that may grow or shrink depending on the choices you make."


          You may be wrong, and realize after the fact that you have lost as compared to what you could have achieved otherwise; or you may be right, and realize what you have gained as compared to what you were going to do instead. Or you may never know, for you will only get one dessert and won't be invited to that restaurant again. Maybe by tasting a bit of each other's desserts, you and a friend can get a better idea of how well you chose; indeed maybe you both enjoy variety in tastes and should split desserts half-and-half. Or maybe at this moment you have something else on your mind, and the stress of not knowing and the cost and risk of learning are not worth it; then you might best pre-commit to the safest choice without looking at alternatives or having any regret afterwards. If you really desire knowledge, you can always order several desserts and make up your mind for sure; but it will cost you, for even if your wallet is deep, you can only stomach so much.

          Which leads us to another important notion about resources: there is more than one resource, and if you can only put a given resource to one use, excluding other desirable uses, you might achieve these desirable uses by spending additional resources; however, this in turn excludes other alternative uses of said additional resources; meanwhile, available resources are limited. What you spend on more cakes won't be spent on other things, such as getting twice as much ice cream, eating something healthier (if less tasty), going to the movies, reading a book, paying for your studies, purchasing tools with which you could make a better living, or even buying survival food if that's where you're at.

          Time, stress, knowledge, health, various material resources, the trust and friendship that people have toward you, and yes, money: life isn't about making the best out of one choice regarding one indivisible resource, but a continuous series of choices in the context of an evolving pool of heterogeneous resources, of which you may allocate parts to various present and future uses, and that may grow or shrink depending on the choices you make.

          Indeed, I already mentioned how eating my cake fast enough might have led to my getting more cake (though eating too fast defeats the whole purpose of the enjoyment of it). In this case, of course, that particular cake had a fixed finite size, but depending on demand, a smaller or bigger cake would be made or bought the next time. On the other hand, eating too much cake might be bad for your health, leading to indigestion, obesity, diabetes, a shorter and more miserable life. At the same time, most of the pleasure can be found in the first few spoonfuls of cake, and in the sensation of being sated afterwards. Therefore eating a small cake at the end of a big meal rather than having a big cake by itself can lead to a longer, happier life with more overall cake enjoyment. A good use of resources can imply more resources as well as more enjoyment; a bad use of resources can lead to faster depletion for less satisfaction. The pie is not fixed.

          How much one can learn from examining the ramifications of one popular saying! Its being somewhat off the point only makes the critical examination of it more enlightening. In French, we mock people who want to have both the butter and the money for the butter at the same time: "avoir le beurre et l'argent du beurre." It's a more accurate depiction of the concept than the English saying, since it presents a trade-off between two desirable alternatives of comparable value in the use of the same resource (some amount of money that can afford some amount of butter). And therefore it's less fun. That's probably why the French tend to outbid each other in ever sweetening the deal, one of them adding the smile of the dairywoman while the other adds her ass instead, and yet another tops it off with the thanks of her husband. After all, if we are allowed to violate the basic laws of economics, why not go full throttle into fantasyland?

          I could go on and on... and I will, eventually. What matters, though, for this first lesson in economics, is that you, gentle reader, may learn to think more like an economist: one who looks at the world in terms of how individuals choose to act with the resources they control; one who understands the concept of opportunity cost and tries to identify the resources at stake behind a choice and the preferences that individuals display as they make these choices; one who evaluates the consequences of these choices and the strategies with which these choices may be made; one who is aware of the importance of knowledge, and of error, in the choices individuals make, as well as the price of acquiring this knowledge.