Note 1: This blog post is entirely cited from the “Opportunity Cost” article in the Macroeconomic book authored by Daron Acemoglu.
Decision and Budget Limitations
Decision-making is one of the most common activities in our daily lives. We are constantly faced with choices: onsite or online working, running or swimming, spending time on social media or reading. A decision essentially involves selecting one option from multiple alternatives, often necessitating the sacrifice of other available choices. For instance, when you opt to spend an hour on social media, you forego the opportunity to read or rest without screens, or even engage in work.
The concept of decision-making isn’t confined solely to our daily lives; it also has economic implications. Economists often describe decision-making in terms of a “budget.” The concept of a “budget” underscores that during the decision-making process, you must adhere to constraints imposed by limited resources. It means you cannot pursue multiple options simultaneously. For example, let’s consider having two choices for your free time: working part-time or surfing the internet. For the sake of this illustration, exclude other activities like eating or sleeping. You are aware that you have only 5 hours of free time apart from your daily commitments. In this scenario, you can represent your current situation with a mathematical equation:
5 Hours = Surfing the Internet + Working Part-Time
As seen in this equation, you have limitations that cannot be ignored. If you spend 1 hour surfing, you will have 4 hours left for work, or conversely, 4 hours of surfing would leave you with 1 hour for work. This concept introduces us to the notion of “Opportunity Cost.”
Opportunity Cost
Opportunity Cost refers to the best alternative that you forgo when making a choice. Human behavior often involves selecting what is perceived as the best option, and in doing so, the next-best option becomes the opportunity cost. For instance, imagine you and your spouse are planning a vacation, but you have limited funds and time. Your options are Miami or Los Angeles. If you choose Miami, then Los Angeles becomes your opportunity cost — the destination you did not select.
Cost-Benefit Analysis
Undoubtedly, time is considered as valuable as money, and this equivalence holds true in economic terminology. Economists have developed a tool known as Cost-Benefit Analysis (CBA), which quantifies value in terms of a common currency, such as the dollar. CBA involves subtracting costs from benefits to make informed decisions in numerical terms. For instance, imagine you have one destination to reach and two transportation options: airplane and car. The airplane ticket is numerically more expensive. However, an important question arises: while we acknowledge that time is money, we seem to overlook the value of time in this scenario. Even though the car expenses amount to $100 per person and an airplane ticket costs $300, people might perceive the car option as cheaper, despite the numerical difference.
How can we calculate the time value of the airplane option?
If you choose the car option, you will spend over 10 hours on the journey compared to the airplane option. The opportunity cost of this choice is arriving 10 hours earlier and working at a minimum wage job, for example, at $25 per hour. With this information, the numerical calculation takes a different turn.
10 Hours * $25 — $300 for the airplane ticket = — $50 > — $100 = Car Expense per person.
Now, the question arises: Which is the better option? At first glance, the car option might seem preferable, but upon closer examination, we realize that the airplane option is more favorable.
I would like to conclude my post by posing a question to my readers: Is using Instagram truly free, or what is the opportunity cost associated with it?
AEÇ
