Wednesday, December 30, 2015

The Problem With Opportunity Cost Is Simple

Comment on: Comparative Advantage: An Idea Whose Time Has Passed by Michael Munger


Imagine King Ralph back in the day. He's trying to decide whether to start a war. He thoroughly understands that wars are very expensive. So if he does start a war... then he might have to forego something else that he also really wants. Like, a much bigger and fancier castle. After much deliberation... King Ralph decides that the war is worth foregoing a better castle.

Is this scenario an example of the concept of opportunity cost? Well yeah. For King Ralph the opportunity cost of war is a better castle. Therefore, as long as the opportunity costs are considered... then there's nothing wrong with allowing one person to decide how everybody's money is spent...

opportunity cost = monarchism/dictatorships

Errrr... what? Something is missing from the equation if the answer is "monarchism" or "dictatorships". So what's missing? Well... what's missing is the fact that King Ralph didn't actually earn the money that's he's spending. Is this a "minor" detail? If anybody thinks so then I'll be happy to give them my paypal address!

Here's how we can modify the equation...

opportunity cost + earner valuation = ?

What's it equal? Clearly it doesn't equal "monarchism"! King Ralph wasn't considering the opportunity cost of his own money. Really the only place where people consider the opportunity costs of their own hard-earned money is the market...

opportunity cost + earner valuation = market

The small problem with this equation is that it's kinda redundant. I should hope that "earner valuation" automatically conveys that the opportunity costs are considered. I don't think that you can valuate anything without considering the (opportunity) costs. The result is...

earner valuation = market

Actually, "opportunity cost" isn't the only economic concept built into "earner valuation". Another built-in concept is Quiggin's Implied Rule of Economics (QIRE)...

It basically states that society's limited resources should create more, rather than less, value for society as a whole. Without this rule there's nothing explicitly wrong with everybody's taxes being wasted on unnecessary wars. In other words, earner valuation is only desirable if our goal is to create the maximum value for society.  This means that opposing earner valuation is the equivalent of supporting the destruction of value.

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