THE COST OF NOT UNDERSTANDING OPPORTUNITY COST

Consider this problem.

Every day you go to the store and buy 100 apples for 40 cents and you sell them on the street for 50 cents. One day, Sally offers to give you 100 oranges for free, but if you drive to her house you won’t have time to buy the apples and you will only be able to sell the oranges that day.

How much do the oranges cost?

You might say your oranges cost you nothing, and in one sense, you would be right. But, let’s say you arrived at Sally’s to discover that the oranges were rotten, and so you couldn’t sell them. Although the price is still zero, now what would you say the oranges cost?

To make it easy for you, we’ll give you only four choices:

A. $0

B. $10

C. $40

D. $50

Before I tell you the correct answer, you should know that when a variant of this question was posed to economists, the right answer was chosen only 21.6% of the time. People who do not study economics get the right answer about 25% of the time because they are just guessing.

The answer is $10 because, had you not accepted the free rotten oranges, you could have bought the apples for $40 and sold them for $50, making $10. Instead, you are making $0.

The fact is, if you could make a $10 profit on the apples, then doing anything else has an opportunity cost of $10. Whether the oranges are free or cost $100, a decision not to trade in apples costs $10 in what you don’t get to do.

Let’s try another puzzle.

You are making $50,000 and someone offers you the identical job for $40,000. What does it cost you to take the $40,000 job? Most people will say that it costs them $10,000 to take a cut, but what they mean is that the opportunity cost is $10,000.

Now, imagine you are making $50,000 and you lose the job. What is the opportunity cost of taking the $40,000 job?

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