The Importance of Opportunity Cost

There is a very important concept in economics called opportunity cost. The idea is that for every decision we make or action we take we must choose to forgo an alternative action or decision. For example if you have one dollar in your pocket and you decide to buy a bag of chips the opportunity cost is a candy bar or pack of gum that you could have purchased with that same dollar.

When observing the economy and the decisions made by economic actors, it is important to always keep in mind the fact that every choice means abandoning some other option.

For business people, this means convincing clients that a dollar spent with their company is a better alternative than choosing a competing product or service. Entrepreneurs, due to the very nature of their position in society, are acutely aware of the phenomenon of opportunity cost. They understand that individuals acting in their own best interest have an enormous variety of options.

Government on the other hand, by its nature, has a very difficult time comprehending opportunity cost. This is because citizens don’t purchase government services voluntarily. If the government were forced to compete for their client’s patronage on the open market, the way that businesspeople have to compete, we would see a much different range of governmental services provided.

For one thing, government employees would make nowhere near as much money as employees of the United States federal government currently make. Price competition is one of the most essential features of the free market. This, in general, leads to lower costs for goods and services and ultimately to lower wages for workers.

However, each individual in a free society, within unhampered market place, has a dual existence. Each of us is both a laborer and a consumer. On the one hand we suffer from lower wages but on the other hand we benefit from lower prices. Both empirical and theoretical evidence show that the process of capital accumulation causes market prices to decrease at a rate faster than the decline in wages. Therefore, in an economy in which all actors are subject to both price competition and the effects of capital accumulation, the standard of living tends to rise for laborers.

When we deviate from the ideal of a free marketplace, the beneficial processes of price competition and capital accumulation are stymied. Instead of an improving standard of living, we see economic stagnation and even a decline in the quality of life in a material sense.

This is a result of opportunity cost. In a very real sense, the opportunity cost of highly paid federal employees is the ever-increasing material enjoyment that one experiences as a result of the free market. Instead of getting goods and services that we demand at cheaper and cheaper prices, we get very expensive services that we don’t even necessarily want or need.

Further, expensive government employees definitely result in unemployment in the private market. This too is a phenomenon of opportunity cost. According to the Bureau of Labor Statistics, the average full-time federal employee makes $74,403 annually. The U.S. Department of Commerce, Bureau of Economic Analysis, Survey of Current Business, informs us that the average personal income for all American workers is $40,584. If we divide the former number by the latter we learn that the opportunity cost of a single government job is approximately 1.83 non government jobs. The money spent on government workers cannot be spent elsewhere.

 

This being the case, it would be quite possible to eliminate a very large portion of our unemployment problem by simply trading government jobs for private jobs. In fact, for every federal job that we eliminate, we will get 83% increase in private jobs. The additional benefit is that private workers, as a result of market competition, will almost certainly be doing work that people actually want them to do.

Of course, economists everywhere will argue that there is no guarantee that the private market will actually rehire all of these government workers. That is true. Workers that are unable to provide value in the free market beyond what they are paid will not be employed. Any worker that can provide services to their fellow man, for which their neighbors will voluntarily compensate them at a profit, must be employed.

This raises a fundamental question: from the viewpoint of opportunity cost does it make sense for us to divert scarce resources into the hands of people who cannot provide sufficient value that people will pay for their services voluntarily? Of course not. Would you choose to spend your hard earned money on a car that won’t start when a drivable car is available? Would you buy a bad tasting sandwich when you have the option provide good taste in one? If so, why in God’s name would you pay somebody above market wages to do something that nobody will pay for the voluntarily?

When discussing economics, government spending, unemployment, and stimulus programs let us never forget that for every dollar we spend on one thing we give up being able to spend a dollar on something else. Every dollar that would employ somebody in the private market will only employee, on average, .54 of a person working for the government. Opportunity cost is a concept of the utmost importance if we are to enjoy an increasing standard of living.

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7 Responses to The Importance of Opportunity Cost

  1. Gbeti kafui says:

    This answers have been useful just that there is little problem understanding some of the concepts

  2. Eniola says:

    All about them is good

  3. Anonymous says:

    nice

  4. Anonymous says:

    impressive

  5. Anonymous says:

    still didn’t get an answer to my question
    but it helped me a little

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