Fun and Games With Opportunity Costs at Law & Society Blog

Fun and Games With Opportunity Costs

Published by Hanno Kaiser September 20th, 2005 in Law and Economics

Consider the following problem, which was presented by Paul J. Ferraro and Laura O. Taylor of Georgia State University to about 200 Ph.D. economists at the 2005 annual meetings of the American Economic Association:

You won a free ticket to see an Eric Clapton concert (which has no resale value). Bob Dylan is performing on the same night and is your next-best alternative activity. Tickets to see Dylan cost $40. On any given day, you would be willing to pay up to $50 to see Dylan. Assume there are no other costs of seeing either performer. Based on this information, what is the opportunity cost of seeing Eric Clapton? (a) $0, (b) $10, (c) $40, or (d) $50.

The correct answer is (b). As with all problems involving opportunity costs, we first need to ascertain the value of the forgone alternative, here, the Dylan concert. I would have been willing to pay $50 for a Dylan ticket (reservation price). If the price of admission was $40, my benefit is $10. That’s what I’m giving up by going to the Clapton concert (or by staying home, etc.) Even though this isn’t a particularly tricky question, most of the respondents got the answer wrong.

[T]he most popular answer was $50, with 27.6% of respondents choosing this answer. The second most popular answer was $40, with 25.6% of respondents choosing this answer. The third most popular answer was $0, with 25.1% of respondents choosing this answer. The correct answer, $10, was the least popular, with only 21.6% of respondents choosing this answer.

Is this “a professional embarrassment?” Does it really warrant the conclusion that

[t]he inability of most PhD economists to answer a simple opportunity cost question implies that students at colleges and universities are unlikely to learn this crucial concept in a way that allows them to apply it in their daily lives.

I don’t know… If anything, the more or less random distribution suggests that the respondents weren’t paying attention. Had this test been administered in a classroom setting, I am certain that most respondents would have gotten the answer right. (And no, I am not making excuses! I wasn’t anywhere near that conference!) But will I sure take solace in the 78.3% error rate, next time that a professional economist makes me look stupid.