Cobra Effect · Decisions and strategy
Opportunity cost
The real price of anything is the best thing you gave up for it.
6 cards, read aloud in 2:18, with a test and sources.
A friend hands you a free ticket to a concert you would quite like to see.
The same night, another band you like is playing. That ticket costs $40. You would happily have paid $50 to see them. The free ticket cannot be sold or swapped. So what does the free concert cost you?
Most people say nothing at all. It was free.
The honest answer is $10. Going to the free concert means giving up an evening you valued at $50, while keeping the $40 you would have spent. So the free evening costs you the $10 of value you chose not to collect. Nothing was ever free. It just never sent a bill.
In 2005 two economists put that question to economists.
Paul Ferraro and Laura Taylor asked professional economists at their own conference. About one in five picked the right answer. There were four options, so guessing would have done about as well. They had all taught the idea. Reaching for it under pressure is another matter.
That is opportunity cost.
The cost of anything is the best thing you gave up to get it. Not the money that left your account. The value of the road you did not take. Friedrich von Wieser named it in 1914, and Frederic Bastiat had the shape of it in 1850. What is seen, and what is not seen.
It bites hardest wherever nothing is charged.
A free meeting is an hour of whatever that room full of people would otherwise have done. A spare room lent to a cousin is the rent it would have fetched. Cash going out of the door is loud. The hour, the room and the evening are silent. Silence is not zero.
So the next time something is offered free, name the runner up.
Ask what you would do with that time, that money or that space if the offer vanished. Put a number on it. That number is the price. A free thing worth less than its runner up is the most expensive item on the table.
Sources
- Do Economists Recognize an Opportunity Cost When They See One?, Paul J. Ferraro and Laura O. Taylor, 2005. The concert ticket question, put to professional economists, with the results. Search the title to find the paper. This page covers the idea itself.
- Economics in One Lesson, Henry Hazlitt, 1946. A whole book built on counting what is not seen as well as what is. Argumentative, old fashioned and very readable.
- Frederic Bastiat, Wikipedia. The essay is called That Which Is Seen, and That Which Is Not Seen, from 1850. It is free online and this page explains where it came from.
Nearby ideas
- The sunk cost fallacy. Money already spent is gone, so it should not steer the next choice.
- Satisficing. Good enough, chosen quickly, often beats the endless hunt for best.
- The Eisenhower matrix. Urgent things crowd out important ones unless you protect them.
- Chesterton’s fence. Before removing a rule, find out why it was put there.
- Inversion. To find the path to success, first ask what would guarantee failure.
- The broken window fallacy. Destruction makes visible work and hides the cost of what was lost.
- The map is not the territory. Every model leaves something out, and that is where it fails.
- The pre-mortem. Imagine the project has already failed, then ask why, before it starts.