5.1 Opportunity Costs
Part 1: Trade-offs
Trade-offs are an inherent part of decision-making, where choosing one option often means sacrificing another. Understanding trade-offs helps us evaluate the costs and benefits of different choices, whether in public policy, economics, or everyday life.
Pharmaceutical Safety and Drug Development
Is it possible that approved pharmaceuticals could become too safe? The answer is yes, and this highlights the concept of trade-offs. On average, it takes 12 years and $1 billion to bring a new drug to market. Increased testing ensures that approved drugs have fewer side effects, but this comes at a cost: drug lag and drug loss. Drug lag refers to the delay in getting medications to patients, which can harm those who could have benefited from earlier approval. Drug loss occurs when the high costs discourage companies from developing new drugs altogether. The right policies for the FDA need to balance the trade-offs of safety with being able to get important treatments to patients quickly.
- Discuss whether it is possible to have too little crime. What trade-offs exist if we tried to bring the crime rate down to zero?
- Discuss whether it is possible to have too little pollution. What trade-offs exist if we tried to bring pollution down to zero?
Part 2: Opportunity Costs
Every choice we make involves something gained and something lost. The opportunity cost of a choice is the value of the next best opportunity you give up when you make that decision. So the cost of something is not just about the money you spend, but also about the time, experiences, and potential benefits you lose by choosing one option over another. Understanding opportunity cost helps us recognize the real trade-offs we face and make wiser decisions.
For example, consider the choice to pursue an MBA. The obvious costs include tuition, books, and room and board. But the opportunity cost isn’t these expenses: it’s what you give up to attend school. If you could have worked full-time and earned $60K/year, then over two years, you’re giving up $120K in potential income.
Opportunity cost is important because it helps us understand the trade-offs of our choices. For instance, during a recession, college enrollment often increases. Why? The cost of tuition or books doesn’t go down, but the opportunity cost of attending college does. When jobs are scarce and unemployment is high, the income you lose by going to school is smaller. In other words, it’s cheaper in terms of opportunity cost to attend college when jobs are hard to find.
- As women began to attain higher levels of education in greater numbers, more women chose to remain in the workforce rather than stay home with children. How does this relate to the concept of opportunity cost?
- Discuss: how does the rise of remote work change the opportunity cost of living in expensive city centers?
Part 3: Marginal Thinking
Marginal thinking involves making decisions by evaluating the additional benefits and costs of a little more or a little less of something. For instance, consider the price of a beer. If the first beer costs $5, it might be worth much more to you in terms of enjoyment, so you buy it. While the second beer may not bring as much enjoyment as the first, its benefit still exceeds the cost of $5, so you purchase it as well. However, after the second beer, your enjoyment diminishes to the point where it’s no longer worth the cost, and you stop buying. Someone who enjoys beer more than you might continue purchasing, and if the price were lower, you might consider buying a third. This is an example of marginal thinking from a consumer’s perspective.
| Marginal Benefit | Marginal Cost (Price) |
|---|---|
| $10 | $5 |
| $6 | $5 |
| $2 | $5 |
| $0 | $5 |
While the marginal benefit exceeds the marginal cost, you keep buying beer.
The principle of continuing an action until marginal benefit no longer exceeds marginal cost is a useful tool for decision-making in various contexts. For instance, if you work at a company and need to decide how much to spend on advertising, this principle helps determine the optimal level of spending. Initially, the marginal benefit of advertising (e.g., increased sales or brand awareness) might exceed the marginal cost (e.g., the cost of running an ad). However, as spending increases, the marginal benefit of each additional dollar may decrease, while the marginal cost perhaps remains constant. The optimal spending level occurs where MB = MC. Spending beyond this point would mean the cost outweighs the benefits, while spending less would mean missing out on potential gains.
- Explain how you could use marginal thinking to decide how many employees to hire. What is the marginal benefit and the marginal cost in this context?
- Explain how you could use marginal thinking to decide how much fertilizer to use on crops. What is the marginal benefit and the marginal cost in this context?
- Explain how you could use marginal thinking to decide how much to study for an exam. What is the marginal benefit and the marginal cost in this context?