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Opportunity Costs and Trade-Offs

Scarcity and Free Time

No person or government can do everything. Recall that because of scarcity, the resources do not exist for that to happen.

  • There will never be enough for natural resources or perhaps the labor will be needed for other things.
  • Capital equipment has its limits.
  • Even the most basic resource - time - is limited.

Assume that you sleep eight hours a day and are at school for eight hours. This leaves you with just eight hours of free time. All of you have made decisions about what to do with your free time. Some of you play sports, march with the band, have an afternoon job, or use your time for study or relaxing.

Opportunity Cost and a Free Lunch

Every decision you make has an opportunity cost associated it. It is important to realize these costs are not always about money. For example, simply relaxing in the yard for an hour is free, but you cannot get that hour back and spend it doing something else, such as studying, working for money, or hanging out with friends.

When students first learn of the idea of opportunity costs they always ask whether opportunity cost applies when someone buys your lunch for you. Many times you are given things you didn't actually pay for. For example:

  • If you go to many stores, they will give you samples of the food that they sell.
  • Many companies will give you free products or services for signing up.

But while you did not pay anything for the products and services, they are not free!

  • On one level they are not free because the costs are spread around to the customers who actually pay for the product. If someone is given money from the government for being unemployed, that is free money, right? That money may be free to that individual, but that funding was paid for by taxpayers.
  • The most important idea to remember is that someone has to pay. Society pays for all "free lunches." The precious resources used to make your free lunch cannot be used to make other items.
  • Economists commonly say "There is no such thing as a free lunch." Many times they abbreviate this with the acronym TINSTAAFL (pronounced tin-stah-full).

Trade-Offs

To economists, the trade-off that would have been the next best alternative is known as the opportunity cost. It is where the choices people and societies make meet the problem of scarcity. The opportunity costs are what must be given up to do choice A rather than B.

Sometimes the trade-offs of opportunity costs are simple to identify. There is a concert and a football game on the same Friday night.

  • If you go to the concert, you will miss the football game.
  • You will also miss the opportunity to be with your friends that have gone to the football game so you may attend the concert.

Businesses face the same sort of trade-offs. A computer software company may want to introduce a new program to its catalog.

  • It may dedicate the time and effort of its programmers onto the new software, at the expense of updating their current offerings.
  • Alternately, the company may hire new programmers for the new software, pay them and find them office space and computers, making the opportunity cost of the new software a financial cost.

Governments face the same trade-offs and opportunity costs. Government budgets reflect decisions made by our legislators. With a budget that is only so big, legislators realize that increasing spending in one area means you spend less in others. In the next lesson, we will go into detail about the "Guns versus Butter" dilemma. A government can have a very large military (the guns) but the lack of funding means there is less to spend on the social programs (the butter).

Every economic student is told that they will become a better overall thinker after taking an economics course. The concept of opportunity cost has more to do with making you a better decision maker. Once you realize every decision you make has a cost, you will become that better thinker.

Check Your Understanding

Think about the following question as you read the article, Opportunity Cost from The Library of Economics and Liberty: Is opportunity cost the next best alternative or is it all about the opportunities missed?

Next, think about the following question as you read the article Getting The Most Out of Life: The Concept of Opportunity Costs from The Library of Economics and Liberty: What does a free lunch have to do with economics?

Based on what you have learned, fill in the blanks below:

Thomas Sowell said it best: No solutions, only __________ (Fill in the blank). To get the most out of life, to think like an _________ (Fill in the blank), you have to know what you're giving up in order to get something else. That's all ___________ ____ (Fill in the blank) is, what you have to ____ __ (Fill in the blank) to get something."

Answers: Thomas Sowell said it best: "No solutions, only tradeoffs. To get the most out of life, to think like an economist, you have to be know what you're giving up in order to get something else. That's all opportunity cost is, what you have to give up to get something."

Marshmallows and Delayed Gratification

What is fun to learn in economics is that we know more about economics than we realize. The next video talks about delaying gratification. Think of money.

  • If I spend it today, I do enjoy whatever I spent my money on. However, if I spend my money today I won't have any for tomorrow.
  • If I save my money for tomorrow, I can't spend it today.

Watch the video Don't Eat the Marshmallow! (5:55) below, which is a TED talk given by Joachim de Posada. The video shows that kids as young as four years old understand the trade-offs with delayed gratification. Pay particular attention to the end of the video where it discusses how successful the kids were who understood the concept of costs and benefits of decisions early in life.