1.2   Why Do We Study Economics and How Individuals and Societies Make Choices

Learning Objectives

By the end of this section, you will be able to:

• Learn a new way of thinking
• Explain opportunity cost

Why do we learn economics? There are many possible reasons:

1. To learn about global affairs
2. To understand society
3. To be an informed voter
4. To learn a new way of thinking

A New Way of Thinking and Understanding Opportunity Cost

John Maynard Keynes (1883–1946), one of the greatest economists of the twentieth century, pointed out that economics is not just a subject area but also a way of thinking. Keynes famously wrote in the introduction to a fellow economist’s book: “[Economics] is a method rather than a doctrine, an apparatus of the mind, a technique of thinking, which helps its possessor to draw correct conclusions.”  In other words, economics teaches you how to think, not what to think.

A classic example of a new way of thinking is the concept of opportunity cost. One of the main concepts in economics that we can relate to is COST. How much does this item costs. But in economics we use the term “opportunity cost”. Opportunity cost is the best alternative that one forgoes when making a decision.

Economists use the term opportunity cost to indicate what people must give up to obtain what they desire. The idea behind opportunity cost is that the cost of one item is the lost opportunity to do or consume something else. In short, opportunity cost is the value of the next best alternative. For example: Alphonso has $10 in spending money each week that he can allocate between bus tickets for getting to work and the burgers that he eats for lunch. Burgers cost $2 each, and bus tickets are 50 cents each. Every time Alphonso decides to have a burger for lunch, he gives up four bus tickets. In other word, the opportunity cost of one burger for Alphonso equals four bus tickets. Because resources such as income are limited, Alphonso must make a decision and give up something else. Whatever he gives up is the opportunity cost.

Identifying Opportunity Cost

In many cases, it is reasonable to refer to the opportunity cost as the price. If your cousin buys a new bicycle for $300, then $300 measures the amount of “other consumption” that he has forsaken. For practical purposes, there may be no special need to identify the specific alternative product or products that he could have bought with that $300, but sometimes the price as measured in dollars may not accurately capture the true opportunity cost. This problem can loom especially large when costs of time are involved.

For example, consider a boss who decides that all employees must attend a two-day retreat to “build team spirit.” The out-of-pocket monetary cost of the event may involve hiring an outside consulting firm to run the retreat, as well as room and board for all participants. However, an opportunity cost exists as well: during the two days of the retreat, none of the employees are doing any other work.

Attending college is another case where the opportunity cost exceeds the monetary cost. The monetary cost includes the out-of-pocket costs of attending college include tuition, books, room and board, and other expenses. However, in addition to the monetary cost, during the hours that you are attending class and studying, it is impossible to work at a paying job. That is the opportunity cost. Thus, college imposes both an out-of-pocket cost and an opportunity cost of lost earnings.

In some cases, realizing the opportunity cost can alter behavior. Imagine, for example, that you spend $8 on lunch every day at work. You may know perfectly well that bringing a lunch from home would cost only $3 a day, so the opportunity cost of buying lunch at the restaurant is $5 each day (that is, the $8 buying lunch costs minus the $3 your lunch from home would cost). Five dollars each day does not seem to be that much. However, if you project what that adds up to in a year—250 days a year × $5 per day equals $1,250, the cost, perhaps, of a decent vacation. If you describe the opportunity cost as “a nice vacation” instead of “$5 a day,” you might make different choices.

This chapter is a remixed version of the chapters 1.1 What Is Economics, and Why Is It Important? and 1.2 Microeconomics and Macroeconomics in Principles of Macroeconomics 3e by OpenStax, published under a Creative Commons Attribution 4.0 International License. Other additions and modifications have been made in accord with the style, structure, and audience of this guide.