Opportunity Cost and Tradeoffs

Opportunity cost and tradeoffs are two fundamental concepts from economics and they are all around us.

Tyler Cowen shares the definition of opportunity cost: the value of your next best alternative. Time, space, or resources used to achieve one goal can’t (usually) be used simultaneously to achieve another. A few examples of opportunity costs show that we face them all the time–even when we’re making decisions that don’t revolve around spending money. Some opportunity costs, like the value of spending time with loved ones, can’t easily be quantified in dollars and cents, so there’s no simple formula or calculator for opportunity cost.

Because resources are scarce, tradeoffs are everywhere. For example, building codes can require entrepreneurs to install sprinklers, safety glass, and other strategies to keep consumers safe. However, the cost of these building improvements can increase the costs of products and prevent new businesses from being opened. Economics can help you understand these tradeoffs so you can navigate them. Once you master the economic way of thinking, you’ll see these tradeoffs everywhere you look.

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00:00 Intro
00:24 Opportunity Cost
01:30 Cost Benefit Analysis
01:58 Tradeoffs
02:37 Examples of Tradeoffs

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- [Tyler] Once you master
the economic way of thinking,

you'll see the world
in a very different way.

Two fundamental economic concepts
are everywhere you look --

opportunity cost,

and tradeoffs.

Let's start with opportunity cost.

At this busy coffee shop,

opportunity costs lie
behind every decision.

Like for Jenny -- she's here
for her third date with Adam.

Was that a good decision?

After all, economics is
all about studying decisions.

Making a good decision is
about comparing the benefits

of that decision to the costs.

The obvious costs for this date,

for Jenny, were the Uber ride
she paid for to get here,

and her grande chai tea latte
with whole milk.

But what's missing?

Her opportunity cost.

Opportunity cost means the value
of the next best alternative.

For instance, instead of going
on her third date with Adam,

Jenny could've been binge watching
her favorite tv show.

She might've been
on a first date instead,

with Roman.

Or she might've been
having breakfast

with her very sweet sister.

Let's say her next best option

would've been
breakfast with her sister.

Does the benefit
of this third date with Adam

outweigh the opportunity cost?

It might seem strange
to think this way about romance,

and it doesn't mean that it's
about calculating every decision

down to the last penny.

Nonetheless, Jenny's time,
attention and energy --

those are scarce.

And if she doesn't consider
the alternatives at all,

she might be wasting
parts of her life.

There's another
fundamental related concept

from economics -- tradeoffs.

Take these sprinklers
in the ceiling of the coffee shop,

for example.

Adding sprinklers can
make it safer during a fire,

but they also can cost
a lot of money to install.

How much cheaper would
the coffee be without them?

In a world of scarce resources,
one typically has to choose.

There's a tradeoff --
safer buildings cost more,

but that means the coffee can
be more expensive.

The line is out the door here.

Perhaps the owner has considered
opening a second location.

As the building code, however,
becomes more stringent,

the cost of opening
an additional location goes up.

It's not just the direct
monetary costs of paying

for things like sprinklers.

It's also the opportunity costs
of the extra time and effort

to file permits, manage the work
and schedule inspections.

A more stringent building code
means a higher cost

for opening up new businesses.

And in turn,
that higher cost can mean

that fewer new businesses
get opened.

What's the right tradeoff
between making buildings safer...

and making it easier
to launch new businesses?

Once you see these tradeoffs,

you'll find them
everywhere you look --

healthcare,

food,

the environment.

education.

One more decision to consider --

if you're a teacher,
should you spice up

your economics class
by checking out our free unit plan

that uses this video?

If you're a learner,
should you watch another MRU video?

Well, YouTube is full
of entertaining videos,

[cat meows]

but please, of course, consider
the opportunity costs.