Making Informed Decisions: a skill for life
Principle #1: People choose; there is no such choice as a free choice.
Objectives:
Identify the opportunity cost of a choice
Use the five steps of benefit cost analysis in major decisions
Distinguish the price of a product from the cost of a choice
Distinguish between:
a decision and a choice
a choice and an alternative
the cost of a choice and a negative consequence of a decision
the cost of a choice and a disadvantage of an alternative
the price of a product and the cost of a choice
Why should you learn this?
Are you kidding me? This is the most important arrow in your Economics-reasoning quiver.
Let’s get to the most important analytical tool in the economics tool kit --- benefit cost analysis. The first thing to recognize is that everyone makes decisions. You decide what time to get your human capital up in the morning, what to eat for breakfast or not to eat breakfast, how to get to school and on and on. Every day is filled with decisions and every decision involves a choice and every choice has a cost…something that is given up. When you decide to hit the snooze alarm, you gain an extra ten minutes of sleep, but you give up whatever you would have done during that ten minutes….maybe a relaxing cup of coffee, or coffee and toast, or whatever. You go to a fast food place and you have enough money for a chicken sandwich meal or a burger meal. You want them both but you only have enough money for one of them. You choose the chicken; the cost of your choice is the burger. When you choose the chicken, you give up the opportunity to have the burger. That is why the cost of a choice is called the opportunity cost. Anytime you make a decision about two alternatives, you select one (the choice) and you give up the other (the opportunity cost.) Every choice has a cost; THERE IS NO SUCH CHOICE AS A FREE CHOICE. You are trying to select a movie. You have narrowed it down to two… a scary movie or a comedy. You select the scary movie (the choice) and you give up the comedy (the opportunity cost). Choice and cost are two sides of the same coin; you can’t have one without the other.
As individuals make decisions about how to use a resource or money, so do groups. As a society, we may choose to preserve Alaskan wilderness or open it up for oil exploration. If we choose oil exploration we give up the wilderness: if we choose wilderness we give up oil exploration. Any time a government uses a resource one way, it gives up the opportunity to use it another way. So the question that any citizen should ask when pondering some government action is, “What will it cost?” According to the Huffington Post, the $400 billion program to create a fleet of F-35 Joint Strike Fighter jets… could have housed every homeless person in the U.S. with a $600,000 home….The full cost of the jets program could also fund the National School Lunch Program which feeds about 31 million students annually for the next 24 years. So, depending on your priorities, the opportunity cost of the jet program could be homeless relief or school lunches, or something else. For you, the opportunity cost is what you think should have been done with the resources. Whatever the opportunity cost is for you, you can’t get around the fact that every choice has a cost. The reason that we can’t have a perfectly clean environment, or the best education for every American, or the finest health care for all is scarcity. Because of scarcity, we have to make decisions and decisions involve gaining something and giving up something. We can’t have it all; resources are insufficient to reach all of our goals.
Notice that opportunity cost is a subjective concept. Only you can decide what the opportunity cost of a choice is for you. The fact that there is an opportunity cost is neither political nor subjective; if you choose one thing, you give up another. But what that opportunity cost is will differ for each person. Some people might say that it is housing the homeless, others might say that it is feeding school children, still others might say that it is building another type of weapon. On a personal level, if you decide to take your human capital to a basketball game on a Friday night, your mom might say that you could be studying, implying that studying is your opportunity cost. But, if you hadn’t chosen to go to the basketball game, you would have spent the night hanging out with your friends. Only you can identify your opportunity cost.
No free lunch; no free choice
There is confusion about the word “free.” It is an Economics mantra that “there is no such thing as a free lunch,” but that statement is misleading because people see “free lunches” in school cafeterias every day. To clarify the concept, it is helpful to distinguish between the price of a product and the cost of a choice. When people receive gifts, they could argue that the gift was ‘free.” It is certainly true that the price of the product to the recipient was zero but there was no realistic choice involved; very few people refuse gifts. If a product has zero price, it is possible to say that the product is free to the recipient. If, however, a person is offered one of two products at zero price, there is a choice involved; the recipient must decide between product 1 and product 2, selecting one and giving up the other. If they choose 1, the cost of the choice is 2. If they choose 2, the cost of the choice is 1. Rather than argue about the statement, “There is no such thing as a free lunch,” it can be agreed that there is no such choice as a free choice; every choice has a cost.
One reason that the concept of opportunity cost is sometimes difficult to understand is because it is not always visible. People don’t always think of the opportunity cost; they see something the want and they buy it or they do it. Nike’s slogan, “Just do it,” suggests that people shouldn’t think about the opportunity cost of a choice. After this course, however, when making major decisions, you can defy Nike and say to yourself, “No, don’t just do it; consider the opportunity cost of the choice.”
Once you understand the concept of opportunity cost, benefit/cost analysis is straightforward. A decision is composed of five steps; 1. Identify the goal and the resources to achieve the goal. 2. Consider two alternative ways to use the resource to achieve the goal. 3. Evaluate the advantages and disadvantages of the two alternatives. 4. Select one of the alternatives – the choice. The alternative not selected is the opportunity the decision-maker gave up – the cost of the choice. 5. Once the decision has been made, consider the consequences of the decision, both positive and negative.
Getting the vocabulary straight. The entire process is the decision. Alternatives are different ways to achieve the goal. Advantages and disadvantages are expected good and bad points of each alternative. The advantages and disadvantages are considered in making the decision; they are part of the process. After careful consideration, the decision-maker selects one of the alternatives as the choice, the alternative not selected is the opportunity foregone – the cost. The word “cost” has an extremely restricted meaning in economics…it is the best alternative given up in making a decision. It is not a consequence of the decision; it is not a disadvantage of an alternative. If there are more than two alternatives, the cost is not all of the alternatives that could have been selected; it is the alternative that would have been selected. After a while, the decision-maker reviews the decision by looking at the positive and negative consequences. A consequence is a result of the decision. Consequences may have been among the advantages and disadvantages of the alternatives (anticipated) or they may not have been (unanticipated). A consequence occurs as a result of the decision.
Here is a silly example. A girl named Bella has decided that she would like to find a guy with whom she will spend the rest of her life. Her resource is her incredible human capital. She has narrowed her alternatives (options from which she can choose) down to two…Jacob and Edward. Now Bella will consider the advantages and disadvantages of both of her alternatives. Jacob is handsome, madly in love with Bella, and he shares Bella’s love of motorcycles. The problem is that he is like a werewolf and can be very dangerous. In addition, he is sort of like a little brother to Bella. And as a werewolf, his wet fur smells pretty bad when it rains. Edward is very rich, smart, and handsome. He is also in love with Bella. The problem is that he is a vampire and can also be very dangerous at times. He also sparkles like gold in the sunlight. After considering the advantages and disadvantages of her two alternatives, she selects xxx, her opportunity cost is xxxxx.
So Bella has gone through the first three steps of benefit cost analysis.
Step 1: Identify your goal and the resources available to achieve the goal. Her goal is to live happily with some guy and the resource that she is going to use is her incredible human capital.
Step 2: Identify your two best alternatives…Jacob and Edward.
Step 3: Consider the advantages and disadvantages of both alternatives. (See above)
Step 4: Select one of the alternatives (xxx is the alternative selected…the choice) and recognize the second best alternative (xxxxx) as the opportunity cost. (I don’t want to spoil it for you if you have’t read the books.)
Step 5: After a time, review the decision to make sure that your choice is still the best choice. Investigate the consequences of the choice. (Well, we just don’t know yet.
Bottom line:
The price of a product is different than the cost of a choice. Things don’t have costs; choices do. There is no such choice as a free choice. Opportunity cost is opportunity lost.
Decision-making involves five steps and some specialized vocabulary. It can be a helpful analytical tool in making your own decisions. Using it thoughtfully, doing your best to gather as much information as possible, and carefully weighing the advantages and disadvantages of alternatives can lead to informed decisions in your personal life, in your decisions about school and work, life after school, and your decisions as a citizen.
Some pithy statements concerning opportunity costl
"To Choose Is to Refuse," "Opportunity Cost Is Opportunity Lost," "Every Choice Has a Cost," and "Things Don't Have Costs, Choices Do."
1. In a decision with four alternatives, how many choices are there?
a. One
b. Two
c. Three
d. Four
2. In a decision with four alternatives, how many costs are there?
a. One
b. Two
c. Three
d. Four
3. After a decision has been made, a negative outcome of the decision is a _____________ of the decision.
a. Cost
b. Consequence
c. Alternative
d. Choice
4. After a decision has been made, a positive outcome of the decision is a _____________ of the decision.
a. Cost
b. Consequence
c. Alternative
d. Choice
5. Using economic reasoning, Susan will make a decision based on:
a. What she has done in the past
b. What her friends are doing
c. What benefit/cost analysis suggests
d. What her older brother told her to do.
6. In terms of benefit/cost analysis, once a person has identified a goal and the resources available to achieve that goal, and listed the alternative ways to achieve that goal, the next step is to:
a. Just do it
b. Consider the advantages and disadvantages of the alternatives
c. Identify the opportunity cost of the choice
d. Rethink the decision
7. Vartan is considering buying a used car. He has narrowed it down to three: a 2010 Honda with 200,000 miles for $5,000, a 2015 Dodge with 125,000 miles for $6500, or his uncle’s old 2008 clunker Toyota Corolla with lots of miles on it (the speedometer broke a couple of years ago) for $500. His order of preference is the Dodge (1), uncle’s Toyota (2), and the Honda (3). He decides to buy the Dodge. Before deciding, his alternatives were:
a. The Dodge, Toyota and Honda
b. The Toyota and Honda
c. The Toyota
d. The Honda
8. Vartan’s choice(s) were/was:
a. The Dodge, Toyota and Honda
b. The Toyota and Honda
c. The Toyota
d. The Dodge
9. The cost(s) of the choice(s) are/is:
a. The Dodge, Toyota and Honda
b. The Toyota and Honda
c. The Toyota
d. The Honda
10. After driving the Dodge for three months, the engine blows. The blown engine is a:
a. Disadvantage of the alternative (the Dodge)
b. Cost of the choice
c. Negative consequence of the decision
d. All of the above
11. Legislators had to decide whether to fund an early childhood education program, a Gifted and Talented Education Program, or an “English as a Second Language” program. They chose the early childhood education program. The (opportunity) cost of their decision was:
a. the Gifted and Talented Program
b. Not getting the Gifted and Talented Program
c. Not getting the Gifted and Talented and Early Childhood program
d. Insufficient information
12. Josefina receives an expensive bracelet that her great aunt Sofia bought for her. Which of the following statements is true about the bracelet?
a. The bracelet is free for Josefina.
b. The bracelet was free for great aunt Sophia.
c. There is no such thing as a free product.
d. All of the above statements are false.
13. Josefina feels bad about her great aunt spending so much money on her. She is thinking about keeping the bracelet or returning it bracelet and using the money to take her great aunt away for a weekend. Her choice is to return the bracelet and use the money to take her great aunt away for a weekend. It rained all weekend but they had a great time anyway. Which of the following statements is true?
a. The choice was free.
b. The cost of the choice was the price of the bracelet.
c. The cost of the choice was keeping the bracelet.
d. A disadvantage of the choice was the rain.
Distinguish between:
a decision and a choice
a choice and an alternative
the cost of a choice and a negative consequence of a decision
the cost of a choice and a disadvantage of an alternative
the price of a product and the cost of a choice
There is no such choice as a free choice. Explain.
Can you use the five steps of the decision-making process to explain a recent decision you have made?
Benefit/Cost Worksheet
What is the goal and what resources are available to achieve that goal?
What are two alternative ways to achieve the goal?
What are the advantages and disadvantages of each alternative?
Which alternative will you choose and which alternative did you give up (opportunity cost)?
What are the anticipated and unanticipated consequences of your decision?
Use Kaylee’s Story to complete the grid below.
Kaylee is a very talented young lady. Smart, great grades, lots of friends, bored to tears, virus quarantine, let’s go to beach on Thursday. No masks, no social distancing. Goal – Have a nice Thursday. Resource – my human capital. Two alternatives – stay home with parents and annoying little brother or go to the beach. The beach sounds really good. Advantages – surfing, volleyball, hang out with friends, juan carlos, disadvantages – risk of virus, worried parents, risk of no surf, bad weather, do most of the organizing, borrow money from parents, Advantage – safe from virus, happy parents Dis – boring, annoying little bro. Choice – staying home; what opportunity did she give up?? The beach. The cost of the choice is the beach. Consequences – happy parents, beautiful hike with not so annoying bro, liver and onions.
Goal and resources available to meet the goal:
Alternative | Alternative | ||
Advantages | Disadvantages | Advantages | Disadvantages |
The choice is ___________________________________________________________.
The opportunity cost of the choice is ___________________________________________________.
The results of the decision are: