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Opportunity cost problem - The Ex-Communicator

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March 5th, 2012


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03:31 pm - Opportunity cost problem
I have been teaching since last May, and next week is my last week. I will miss teaching. Among other things I have been teaching economics (at a basic level) so I was interested in This metafilter discussion of the 'Dylan-Clapton dilemma'.

This is the problem. You must pick an answer using only the information provided:
"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 D. $50"

Opportunity cost means 'the benefit of your second-best alternative' ie the benefit you give up when making a choice.

I have been teaching a particular solution to this type of question for best part of a year now, so I was pretty nervous about clicking on the answer (answer explained in full here and also below the cut). Luckily I did get it right. But it is interesting that economists in general get it wrong.
"when researchers asked 200 economists at the annual meeting of the American Economic Association, to answer this question only 22% got it right, a smaller percentage than if they had chosen randomly... when they posed their original question to a large group of college students, the researchers found that exposure to introductory economics was counterproductive. Among those who had taken a course in economics, only 7.4% answered correctly, compared with 17.2 % of other students."

Answer below.

The answer is $10. For the following reason:

- Going to the Dylan concert is your second best alternative (that is given in the problem) therefore the opportunity cost is the net benefit of seeing Bob Dylan which you have forgone by going to Clapton.

- Also in the problem, you know that seeing Dylan is worth $50 to you (gross benefit = 50) and seeing Dylan will cost $40 (cost = 40)

- Therefore net benefit to you of seeing Dylan is 10 (50-40)

- Therefore opportunity cost = $10

(22 comments | Leave a comment)

Comments:


[User Picture]
From:espresso_addict
Date:March 5th, 2012 04:20 pm (UTC)
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I'd have picked zero because there exist other opportunities to hear Dylan, so one is not giving up the opportunity to hear him, merely postponing it.
[User Picture]
From:communicator
Date:March 5th, 2012 04:45 pm (UTC)
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The reason that's not 'right' in the economics sense is that you are giving up this particular case. The other issues (there might be other chances for example) are all factored in to your decision to give up. Opportunity cost has a specific technical meaning in economics, which is why it is kind of tragic that economics students got it wrong more often than others.
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From:del_c
Date:March 5th, 2012 04:58 pm (UTC)
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Something I don't get about the web site example is that it says the cost of seeing Clapton that night is zero, and so is the benefit. But by my calculations that means you're foregoing the $10 of [benefit - cost] that seeing Dylan would bring you, for an experience that is free but that you regard as worthless. So why did you go to see Clapton?

I get that you don't need to know what the person in the puzzle would have paid to see Clapton (we never even needed to know that the Clapton tickets were free). But if this is an economics question about the decisions people make, haven't we got to make some noises about how you decided to see Clapton because the [benefit - cost] beat Dylan that night? The questioner doesn't have to reveal how big a Clapton fan you were at the beginning of the question, because that would give away the answer, but surely in retrospect, can't we assume you thought Clapton was worth at least $10 of your money, and that was why you ditched Dylan?
[User Picture]
From:communicator
Date:March 5th, 2012 05:22 pm (UTC)
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Yes, you can assume that seeing Clapton is worth more than $10 to you, because otherwise you wouldn't have chosen that option.

The opportunity cost is $10, and the benefit of going to Clapton is $10+x. You don't know what x is, but it is some positive number or you would have given up the free ticket.

(ETA - sorry I wasn't answering your question. I agree with you - I think the web site is wrong to say the benefit to you of seeing Clapton is zero)

Edited at 2012-03-05 07:54 pm (UTC)
[User Picture]
From:sheenaghpugh
Date:March 6th, 2012 11:53 am (UTC)
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"I think the web site is wrong to say the benefit to you of seeing Clapton is zero)"

Oh, I agree with them on that - I can't stand him.
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From:watervole
Date:March 5th, 2012 05:53 pm (UTC)
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I disagree with their answer.

The question says "Bob Dylan is performing on the same night and is your next-best alternative activity." which suggests that the ticket buyer actually prefers Clapton (next-best).

Therefore, I'd say there is no opportunity cost.
[User Picture]
From:communicator
Date:March 5th, 2012 08:00 pm (UTC)
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The opportunity cost just means 'what you have given up'. But you are still better off overall. The opportunity cost is the benefit you rejected, and it must be less than the benefit you accepted. The problem is expressed in economics jargon rather than normal use of language. And there's an overall assumption that people choose rationally.
[User Picture]
From:executrix
Date:March 5th, 2012 08:28 pm (UTC)

Assume a Can Opener

(Link)
They jiggered the hypothesis until they got the answer they wanted! I know that no equation can include all of the factors, but just in a few minutes' brooding I came up with:
* It's unrealistic to say the free ticket has no resale value--even if it's forbidden to re-sell it, well, people ALWAYS follow the rules, don't they? And even if the winner chooses not to re-sell, ze could barter it with a Clapton-loving friend who would gladly baby-sit, drive the winner's Mum to the hairdresser, give up her secret recipe for Christmas pudding, etc.
* It doesn't say that they're both one-night stands, in the real world one could probably go to the following night's Dylan show
* In fact, if they're playing clubs and not stadium gigs, you might be able to hear both of them the same night, one at the early show and one at the late show
* Is there going to be footage of one or both on YouTube in the near future?
* Are they both playing new music or old stuff and, if new music, do you already know you love it/already know you hate it?
* Neither of Clapton nor Dylan is a spring chicken--I mean, Leonard Cohen is actually touring now and I suspect lots of tickets are sold on the basis of Last Chance
[User Picture]
From:communicator
Date:March 5th, 2012 10:13 pm (UTC)

Re: Assume a Can Opener

(Link)
You might be interested in a discussion on Crooked Timber called 'Occam's Phaser' (great title). That's about the use of outlandish thought experiments in philosophy which try to over-control the factors. Economics is worse than philosophy in this.
[User Picture]
From:executrix
Date:March 5th, 2012 11:06 pm (UTC)

Re: Assume a Can Opener

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Thanks for the link!

Economics is not only worse than philosophy in designing thought experiments...governments pay a lot of attention to economics and none to philosophers, so it really matters if economists get things wrong.
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From:pennski
Date:March 5th, 2012 08:57 pm (UTC)
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We actually use this in factoring in what deals to use in supermarkets - somebody explained it to me late last year but I'd forgotten the terminology!
Therefore I was delighted that I was able to get the "theoretically" correct example (ignoring all the useful real world stuff in the other comments which would actually factor in normally).
[User Picture]
From:communicator
Date:March 5th, 2012 10:14 pm (UTC)
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Yes. I suppose one issue which is left for me is whether there is any point in economics at all. I think there is, but there needs to be greater humility among economists. Fat chance.
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From:sheenaghpugh
Date:March 5th, 2012 10:06 pm (UTC)
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I knew I was thick about maths - even with your explanation, I just don't have a clue what opportunity cost means and I couldn't begin to answer the question.
[User Picture]
From:communicator
Date:March 5th, 2012 10:20 pm (UTC)
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It's a particular kind of jargon. The cost of any choice is the alternative you turned down.
[User Picture]
From:sheenaghpugh
Date:March 6th, 2012 11:49 am (UTC)
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Still don't get it. This is the sort of question that convinced me at school that maths had no role in the real world, once you'd learned enough to count your change. As others have said, it isn't remotely realistic - the ticket IS resaleable, legally or not, and anyone who didn't want it would resell it; the two concerts aren't true alternatives because there would be ways to see both artists, and the only thing that really matters is which one you want to see the most.
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From:kalypso_v
Date:March 6th, 2012 12:59 am (UTC)
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Well, I was generally considered quite good at maths, but I couldn't make head or tail of it either.
[User Picture]
From:kerravonsen
Date:March 6th, 2012 02:45 am (UTC)
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Me neither.
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From:communicator
Date:March 6th, 2012 07:51 am (UTC)
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Yes, it's not really a maths problem at all
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From:azdak
Date:March 6th, 2012 04:55 am (UTC)
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Okay, I think I understand now, but it's very counter-intuitive - because as a non-economist I would have thought the opportunity cost was zero, seeing as I wanted to see Clapton more than Dylan anyway and hadn't forked out any cash for a Dylan ticket. However, even trying to think like an economist, it seems strange to think of the "lost benefit" of seeing a concert in terms of how much less the ticket would have cost me, had I bought it, than I was willing to pay. If I had been prepared to pay up to €40 (sorry about the currency change, this is a German keyboard and it doesn't seem to have a dollar sign) and the ticket would have cost €40 then the opportunity cost of going to see Clapton would have been zero, is that right? So if I was a millionaire, and a huge Dylan fan (but an even bigger Clapton fan) who would happily have forked out €2000 for a ticket to see my hero, then the opportunity cost of going to see Clapton would have been €1,960? It's good to know that there is a parallel universe where free tickets cost millionaires a great deal more than ordinary people.
[User Picture]
From:communicator
Date:March 6th, 2012 07:50 am (UTC)
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If you were friends with Richard Branson and he offered to take you up into space, but instead you went to a free Clapton concert, then the opportunity cost might be a million quid.
[User Picture]
From:azdak
Date:March 6th, 2012 10:22 am (UTC)
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Unless, of course, I was willing to pay at least a million quid to avoid being trapped in a small space with Richard Branson? In which case my free Eric Clapton ticket would be the bargain of the century.
[User Picture]
From:tehomet
Date:March 10th, 2012 11:44 pm (UTC)
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Crikey. Why did taking a course in economics make students less able to answer the question correctly, I wonder?


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