No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Two: Fundamentals of Economic Behavior 40 Opportunity cost refers to the next highest valued opportunity forgone by our choice. If we go to the gym on Saturday, and our second choice would have been to go to the movies, the cost of going to the gym is the movie. This cost, like all costs, is subjective— meaning we only assess this cost in our minds, we alone bear the cost, and we bear that cost at the moment of choice. 1 We imagine how we would enjoy the movie, and that subjective assessment of satisfaction we would gain from the movie is what we give up when we choose to go to the gym. This cost is not objective, and cannot be known by anyone else. It is true that most people can appreciate the costs of choices we make, because they make similar choices and suffer the costs all the time. But they are not the same costs. When Bob tells you he’s going to study on Saturday so he doesn’t fail his economics test on Monday rather than going to the movies, you may understand…to a degree. But you don’t know how highly he valued that movie. Certainly there is no measure of lost satisfaction that you can apply to his choice—no “units of dissatisfaction” that are a common standard that you and he feel the exact same way. Opportunity cost means we must give up something with every choice we make—our next best alternative. THE FIRST LAW OF ECONOMICS IS SCARCITY! SCARCITY MEANS THERE IS NO FREE LUNCH! How much lost satisfaction from any given choice in part depends on how much of the good we have consumed. For example, if the opportunity cost of a Coke is an order of fries, it makes a big difference if we’ve just devoured three large fries in the last fifteen minutes or if we’ve had nothing to eat for the last 24 hours. Our choices are always made on the margin . Marginal analysis is a crucial consideration in how we choose. The margin is simply the unit we are focusing on when we make a choice. Some examples will help illustrate this point. We’ll look at the easiest example first. Let’s say you are asked if you want a glass of water, or if you’d prefer a diamond—your choice. For almost all of you, you’ll immediately say “give me the diamond.” But what if you’ve been out in the desert for two days, and you happen to come upon a fresh water stand? The hard-hearted entrepreneur offers to sell you a gallon of water for the diamond ring you’re wearing—enough water to allow you to cross the remaining stretch of desert into a town. In that case, you’ll likely hand over the ring, since it’s that or die. You value the water over the diamond at that particular moment. The key valuation is not water in general vs. diamonds in general; it is a specific amount of water against a specific diamond. That specific unit is the additional or marginal unit: the unit of choice. There is no doubt water is much more valuable than diamonds; we need water to live and diamonds are just pretty baubles. But that is never the question. The question is always: is this particular amount of water at this particular time more valuable than this marginal: the additional unit being considered