Tuesday, November 30, 2010

A deceptively simple economics question

This economics question popped up in the New York Times some years ago:
"You won a free ticket to see an Eric Clapton concert (which has no resale value). Bob Dylan is performing on the same night and is your next-best alternative activity. Tickets to see Dylan cost $40. On any given day, you would be willing to pay up to $50 to see Dylan. Assume there are no other costs of seeing either performer. Based on this information, what is the opportunity cost of seeing Eric Clapton? (a) $0, (b) $10, (c) $40, or (d) $50."

The opportunity cost of seeing Clapton is the total value of everything you must sacrifice to attend his concert - namely, the value to you of attending the Dylan concert. That value is $10 - the difference between the $50 that seeing his concert would be worth to you and the $40 you would have to pay for a ticket. So the unambiguously correct answer to the question is $10. Yet only 21.6 percent of the professional economists surveyed chose that answer, a smaller percentage than if they had chosen randomly.
Clearly the opportunity cost here is $10. Why? Because if you are willing to pay up to $50 for something and you are given an opportunity to buy that thing at $40, then that opportunity is equivalent to you possessing a $10 coupon. So what is the cost of letting your $10 coupon expire? $10.

So this is the economics version of “What color is George Washington’s white horse?” Here's Vox Day's answer (boldface in original):
Since various people are tripping all over their various attempts to define "opportunity cost" instead of paying attention to how it was defined in the question, I will highlight the relevant portion of the question posed by Frank here.

"The opportunity cost of seeing Clapton" is the total value of everything you must sacrifice to attend his concert - namely, the value to you of attending the Dylan concert."

The value of attending the Dylan concert to you is $50. This means the value of the discount on the ticket is $10. Now, it's vital to note that Frank assigns TWO distinctly different definitions to "the opportunity cost of seeing Clapton" in his question, thus conclusively proving his point that economists, especially economists writing in the New York Times, don't understand opportunity cost. Naturally, there are two different answers to the two different questions-in-the-question. The answer to question (A) the "total value of everything you must sacrifice", is $60 since you're giving up both the value of the Dylan concert and the value of the discount in order to see Clapton. The answer to question (B) the "value to you of attending the Dylan concert" is $50. However, the four multiple choices provided make it clear that Frank is looking for an answer to question (B) rather than question (A), which is why the correct answer is (d) $50.
Vox Day is arguing that if you DON'T buy the ticket, then you lose the $50 value of the ticket, and you lose the $10 value of the discount, and you don't have to offset this loss against the purchase price of the ticket that you didn't buy. Ken Lay call your office please!!! I think Vox just discovered a way to save Enron.

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