Opportunity Cost

Basically, this question can possibly be answered using two different approaches that might result into different opportunity costs. However, the calculation should be derived from the fundamental definition of an opportunity cost. According to Keat and Young (2009), opportunity cost is a concept stating the economic cost incurred in deploying resources in specific activities and this usually depict the value of the perhaps best forgone choice of using those resources. Stigler (1963) on the other hand perceive opportunity cost of an item or activity as what an individual is willing and ready to give up in order to obtain that item. Thus, based on these definitions, the resulting answers from the calculation show one that illustrate an opportunity cost as the foregone benefit accruing from making decision and the other one that shows an opportunity cost as the foregone net gain ensuing from making a viable decision.

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Calculating the opportunity cost using two different methods

Based on the above opportunity cost question, there are two possible opportunity cost answers namely $10 and $50. However, the best answer absolutely depends on how the Dylan ticket cost is understood. In fact, the cost can either be assumed to reduce the opportunity cost or a cost saving benefit which an individual realizes when the decision to attend the Clapton concert is made. If $40 is explicitly treated as a benefit, it becomes more logical and equally in harmony with the meaning of an opportunity cost. Hansen et al., (2002) stresses that there is the need to assume the following key variables when handling the question:

BD = the benefit derived from seeing Dylan, which is $50

CD = the cost incurred to see Dylan, which is $40

BC = the benefit derived from seeing Clapton, not given

CC = the cost to see Clapton which is $0 since the ticket was free and had no resale value.

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The choice to attend Clapton’s concert in preference to Dylan concert entirely relies on the payoff accruing from attending the Clapton as opposed to Dylan. Let us take this as PayoffC. Thus, when the payoff materializes to be negative then it is viable to attend the Dylan concept but if it is above zero, an individual should attend the Clapton concert. The two PayoffC representations are as below.

Approach 1

This approach evaluates the net-payoff emanating from attending Clapton’s concert and that of attending Dylan’s concert. For instance,

(i) PayoffC= (BC-CC) – (BD-CD). Since CC=$0, the opportunity cost of attending the Clapton concert would be the net benefit that should have been derived from seeing Bob Dylan concert which is in turn foregone when the verdict to see Eric Clapton is Made, and this is $50-$40=$10

Approach 2

Whereas the above method appears logical, we can as well reconsider an alternative approach through grouping the entire benefits derived from attending Clapton concert over those of seeing Dylan against the costs of attending Clapton concert over Dylan’s concert. That is,

(ii) PayoffC = (BC+CD) – (CC+BD). From this equation, CD is the cost saving benefit ensuing from having Clapton’s concert as a preference over Dylan’s concert. This value can be logically used as a benefit because the cost saving from the ticket purchases represents resources that the verdict maker may now redirect towards buying other commodities. CC is the unambiguous cost outlay of Clapton’s ticket and BD is ideally the foregone benefits of failing to see Dylan.

If we compare the accruing benefit against the incurred costs, we obtain PayoffC= (BC+40) – (50+0). Therefore, the opportunity cost is $50 since this represents the foregone benefit value of failing to see Dylan.

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Despite the fact that $10 is the alleged unambiguously correct opportunity cost as it directly represents the cost of everything that must be given up in pursuit of the best alternative activity, there is the need to take into consideration the cost of not attending the Dylan‘s concert which consequently yields $50 as elicited in the second approach. Nevertheless, Colander and Arjo (1987) asserts that the correct decision will always be made irrespective of the approach.

References

Colander, D. & Arjo, K. (1987). The Making of an Economist. Journal of Economic Perspectives, 1(2): 95-111.

Hansen, W. L., Salemi, M., K. & Siegfried, J., J. (2002). Use it or lose it: Teaching literacy in the economics principles course. American Economic Review, 92(2): 463-472.

Keat, P., G. & Young, P., K., Y. (2009). Managerial Economics: Economic Tools for Today’s Decision Makers. Upper Saddle River, NJ: Prentice Hall.

Stigler, G., J. (1963). Elementary Economic Education. American Economic Review, Papers and Proceeding, 53(2): 653-659.

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