Opportunity Cost For Individuals

Virtually every action we take as individuals uses up scarce money, scarce time, or both. Hence, every action we choose requires us to sacrifice other enjoyable goods and activities for which we could have used our money and time. For example, it took a substantial amount of the authors' time to write this textbook. Suppose that the time devoted to writing the book could instead have been used by one of the authors to either (1) go to law school, (2) write a novel, or (3) start a profitable business.

Do all three of these alternatives combined make up the opportunity cost of writing this book? Not really. Choosing not to write the book would have released some time but not enough time to pursue all three activities. To measure opportunity cost, we look only at the alternatives that would have been chosen—the ones that are actually given up. Suppose that for one of the authors the next best alternative to writing this book was to start a profitable business. Then the opportunity cost of co-authoring this book was the foregone opportunity to start the business. Since the other, less valuable alternatives would not have been chosen anyway, they are not part of the cost of writing the book.

To explore this notion of opportunity cost further, let's go back to the earlier question: What does it cost to see a movie? That depends on who is seeing the movie. Suppose some friends ask Jessica, a college student, to go with them to a movie located 10 minutes from campus. To see the movie, Jessica will use up scarce funds to buy the movie ticket and scarce time traveling to and from the movie and sitting through it. Suppose the money she uses for the movie ticket would otherwise have been spent on a long-distance phone call to a friend in Italy—Jessica's next best use of the money— and the time would otherwise have been devoted to studying for her economics exam—her next best use of time. For Jessica, then, the opportunity cost of the movie consists of two things given up: (1) a phone call to her friend and (2) a higher score on her economics exam. Seeing the movie will require Jessica to sacrifice both of these valuable alternatives, since the movie will cost Jessica both money and time.

Now consider Samantha, a highly paid consultant who lives in New York City a few miles from the movie theater, and who has a backlog of projects to work on. As in Jessica's case, seeing the movie will use scarce funds and scarce time. But for Samantha, both costs will be greater. First, the direct money costs: There is not only the price of the movie ticket, but also the round-trip cab fare, which could bring the direct money cost to $20. However, this is only a small part of Samantha's opportunity cost. Let's suppose that the time it takes Samantha to find out when and where the movie is playing, hail a cab, travel to the movie theater, wait in line, sit through the previews, watch the movie, and travel back home is three hours—not unrealistic for seeing a movie in Manhattan. Samantha's next best alternative for using her time would be to work on her consulting projects, for which she would earn $150 per hour. In this case, we can measure the entire opportunity cost of the movie in monetary terms: first, the direct money costs of the movie and cab fare ($20), and second, the foregone income associated with seeing the movie: ($150 X 3 hours = $450)—for a total of $470!

At such a high price, you might wonder why Samantha would ever decide to see a movie. Indeed, the same reasoning applies to almost everything Samantha does besides work: It is very expensive for Samantha to talk to a friend on the phone, eat dinner, or even sleep. Each of these activities requires her to sacrifice the direct money costs plus another $150 per hour of foregone income. Would Samantha ever choose to pursue any of these activities? The answer for Samantha is the same as for Jessica or anyone else: yes—if the activity is more highly valued than what is given up. It is not hard to imagine that, after putting in a long day at work, leisure activities would be very important to Samantha—worth the money cost and the foregone income required to enjoy them.

Once you understand the concept of opportunity cost and how it can differ among individuals, you can understand some behavior that might otherwise appear strange. For example, why do high-income

In some cases, the entire opportunity cost of a decision can be expressed as a single dollar figure. For example, Samantha's ticket, cab fare, and even the time spent at the movie are all easy to value in dollars (the value of the time is equal to the dollars Samantha could have earned at the next best alternative—working). But what if some part of opportunity cost cannot be easily measured in dollars? Then we simply express the opportunity cost as several different things, rather than a single number. For example, suppose that Samantha's next best alternative to the movie was not working, but attending a friend's birthday party instead. Then the opportunity cost of the movie would consist of both the dollar cost (ticket plus cab fare) and the missed birthday party.

people rarely shop at discount stores like Kmart and instead shop at full-service stores where the same items sell for much higher prices? It's not that high-income people like to pay more for their purchases. But discount stores are generally understaffed and crowded with customers, so shopping there takes more time. While discount stores have lower money cost, they impose a higher time cost. For high-income people, discount stores are actually more costly than stores with higher price tags.

We can also understand why the most highly paid consultants, entrepreneurs, attorneys, and surgeons often lead such frenetic lives, doing several things at once and packing every spare minute with tasks. Since these people can earn several hundred dollars for an hour of work, every activity they undertake carries a correspondingly high opportunity cost. Brushing one's teeth can cost $10, and driving to work can cost hundreds! By combining activities—making phone calls while driving to work, thinking about and planning the day while in the shower, or reading the morning paper in the elevator—the opportunity cost of these routine activities can be reduced.

And what about the rest of us? As our wages rise, we all try to cram more activities into little bits of free time. Millions of Americans now carry cell phones and use them while waiting for an elevator or walking their dogs. Books on tape are becoming more popular and are especially favored by runners. (Why just exercise when you can also "read" a book?) And for some, vacations have become more exhausting than work, as more and more activities are crammed into shorter and shorter vacation periods.

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