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People Don’t Understand Opportunity Costs; Nor Do They Know How To Quantify Them

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Over and over again in the past many years, I have seen people stake out public policy positions or implement policy with zero regard for what is known as “opportunity costs”. Opportunity costs are the first concept you learn in basic economics. Economics isn’t the study of business or markets. It’s the study of scarcity and opportunity costs are an integral part of the equation.

Usually, they are explained like this. “Investors are always faced with options about how to invest their money to receive the highest or safest return. The investor’s opportunity cost represents the cost of a foregone alternative. If you choose one alternative over another, then the cost of choosing that alternative becomes your opportunity cost.”

Our immediate thought is money. Economics is considered “business study” and since businesses exist to solve problems for customers and make money for employees and shareholders, we focus on money. I am doing a rehab of my house in Las Vegas. There is the cost, but the opportunity cost as well. Warren Buffett likes to say a haircut doesn’t cost him $30, but $300,000.  Economics is really a way to study society, behavior, and decision-making.

Most people look at the accounting numbers when totaling up the costs, not the real economic numbers. Those numbers will tell you a different story and lead to a decision-making process. When it’s money, it can be difficult to figure out opportunity costs but it becomes very complex when we apply basic economics to other problems.

Take this article written by Northwestern law professor Ronald J. Allen. I love it because it explicitly outlines the way he was looking at the opportunity costs of making one decision versus another. He is analyzing the policy of defunding the police.

He writes,

There are on average 15 police killings in Illinois each year. If that were lowered to zero by taking all the police off the streets, the trade-off would have been the saving of 15 lives and the loss of at least 245. Suppose the estimate is double reality. Then it would be 15 to 122. That looks like a very bad trade-off in any sensible cost-benefit analysis. And consider its racial implications. The victims are minorities: “Of the 2016 victims, 78% were African-American, 16% were Hispanic, and 5% were white.” Cassell has done a similar nationwide study of the effect of the demonstrations that occurred in 2020 with the resultant attacks on the police. Again, the data show the same striking correlation between the protests, attacks on the police, police pullbacks, and a spike in violent crime in large cities.

But, it goes deeper. What’s the cost of a single human life? Most of the people being killed are younger. They had untapped potential that will never be realized. What are the costs to the neighborhoods? People are probably expending money on taking extra precautions so they aren’t randomly shot. Are they choosing not to leave their homes? That has a cost.

In my cabin town of Grand Marais, Minnesota, there is a small protest today over a pipeline being built. Those people have zero idea of the opportunity costs of not building the pipeline. Of course, they are using identity politics to make their points. Pipelines are the most environmentally friendly way to transmit oil. We need oil to power cars and our economy today. You might hope someday we won’t, but even an all-electric vehicle society will need massive amounts of energy to sustain itself. More energy than we produce today as a matter of fact. It’s funny when I engage with those people who bring up global warming. But, the counterpoint to global warming is to build lots and lots of nuclear plants to provide clean, green, cheap energy to everyone that could sustain a worldwide electric vehicle fleet along with satisfying the demand for energy from an information economy.

When I look at Covid over the past year, the opportunity costs weren’t even considered when the policy was made. Shutdowns had a massive opportunity cost. Far greater than the costs of not shutting down especially when you look at the data today.

As we are learning in real-time if you are paying attention, bureaucrats and many politicians have no regard for your safety or well-being. All they want is brazen power over your life.

The short answer is we should have never shut down the worldwide economy. We should have done what we could to protect vulnerable people. The reality is, most of us were not vulnerable to dying.

The post People Don’t Understand Opportunity Costs; Nor Do They Know How To Quantify Them first appeared on Points and Figures.



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