Do Economists Understand Opportunity Cost?

When I took Macroeconomics with Richard Harris at SFU in 2003, he remarked one day that "there are only two things you really need to learn as an undergraduate in economics: the government budget constraint and the concept of opportunity cost." I reflected back on that comment when I read this New York Times article:

Virtually all economists consider opportunity cost a central concept. Yet a recent study by Paul J. Ferraro and Laura O. Taylor of Georgia State University (which is short and well worth reading in full, by the way) suggests that most professional economists may not really understand it. At the 2005 annual meetings of the American Economic Association, the researchers asked almost 200 professional economists the following question:

"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." (answer at the end of the post)

The proportion of professional economists able to answer this question correctly?

21.3%. All of the available answers were selected with roughly equal frequency.

Let's pause a moment to contemplate the shocking awfulness of this result. Here we have 200 professional economists, most of them tenured professors at top universities, more than half of them responsible for teaching undergraduates, all of them capable of covering chalkboards with mind-binding mathematics... yet most of them are baffled by a problem from page 4 of Ben Bernanke's introductory economics textbook.

Is there any other academic field so disconnected and untethered from its own basic principles? Would a convention of physicists be unable to answer freshman questions about a ball rolling down an inclined plane?

The paper contained various defences of the economics profession in the face of this result, all of which were unsuccessful in my opinion, but one of which reflected a prejudice in the discipline that as a newcomer to economics I'd already noticed: the idea that the clarity and precision of definition is irrelevant to the skill of correct economic reasoning. It doesn't matter if you know what any of the terms mean, as long as you come up with the "correct result".

In fact, the authors of the paper surveyed nine major introductory textbooks and noted that only two of them provided a clear enough definition of the supposedly crucial concept of opportunity cost (emphasizing that both the costs and benefits of the alternative action must be weighed) in order to enable the question to be answered. The disdain for precision in this supposedly rigourous science is tolerated throughout the discipline.

However, I would assert that the economists' casual approach to clarity of meaning has two grave drawbacks. It is pedagogically ineffective (as evidenced by another fact noted in the paper - that students taking the above survey performed WORSE after taking an economics class than they did before), and it is intellectually dangerous; it flies in the face of 2,000 years of philosophical tradition on what it means to reason well and think clearly.

"If you wish to converse with me," said Voltaire, "define your terms." How many a debate would have been deflated into a paragraph if the disputants had dared to define their terms! This is the alpha and omega of logic, the heart and soul of it, that every important term in serious discourse shall be subjected to the strictest scrutiny and definition. It is difficult, and ruthlessly tests the mind; but once done it is half of any task. Will Durant, The Story of Philosophy (Chapter 2, Aristotle and Greek Science, Part 3, The Foundation of Logic).

The sophisticated manipulation of symbols counts for little if you don't know what the symbols really mean. Clarity matters. Without fully understanding opportunity cost you can't conduct cost/benefit analysis properly. You can't understand economic rent (not that modern economics has much interest in doing so, but that's another topic). You can't fully understand welfare economics. An important concept, indeed!

To any of my former colleagues from Queen's who happen to be reading this, I urge you: do better. Make the discipline better. Encourage it to think harder about what it does and says, and how it does and says it.

By the way, the answer is $10. (I myself got it wrong). Opportunity cost is defined as "the value of the next best alternative", but it is seldom emphasized that both the costs and benefits of that alternative must be considered. The Bob Dylan concert has a WTP of $50, but a ticket price of $40. The net benefit of attending the Dylan concert is 50-40 = $10, and that is the opportunity cost of attending the Eric Clapton concert.