What are Trade-Offs & Opportunity Costs? Overview with Example

In this article, we're gonna discuss trade-offs and opportunity costs in economics. So if you remember the fundamental economic problem, we have finite resources, but we have an infinite number of wants. We want better health care because we want better education for our children we want all these things, but we have a finite or limited amount of resources to satisfy all those wants.


And so we have to make trade-offs. We have to sometimes to get "X" I have to give up some of "Y" for example, if you really believe in the importance of doing diabetes research and you know "We're just not spending enough money on diabetes research our country needs to do better" you could spend more but remember that every dollar that is spent on diabetes research is not available to be spent on something else like military defense or education. So if we spend more money on diabetes research that's less money that we can spend somewhere else. It's not to say that we shouldn't be spending money on diabetes research but we have to think about the trade-offs involved and we have to think about what are we giving up in order to get that extra spending on diabetes research. What we're giving up we're gonna call that the opportunity cost. It's the cost of the thing that we give up. 


So a dollar spent on diabetes research assuming that you would have otherwise spent that on military defense then the cost would be a dollar of military defense also if you think just personally an hour that you could spend studying for class, let's say on a Friday night is an hour that you can't spend skydiving. You can't do studying and skydiving at the same time presumably. So you have to choose you to have to weigh the trade-offs and say what I really want to do here and people complain about things, for example, airline security and having to wait in long lines but then by the same token people want security. So you have to trade-off, we have to think about how much security do we really want how much security is important because the more security we get we might have to wait in line longer, we might have to pay more money for an airline ticket. 


I want to give you an example,  let's think of a pick policy that in the United States for example more than 30,000 people die every year from car accidents. So you say "I don't like that I want to reduce the number of deaths that we have occurred every year from automobile accidents" So it's a noble goal and let's say you were in charge of the economy or you're in charge of the government and you say you know what we're gonna make driving illegal and everybody goes along with that and says "Yeah that's a good idea we need to reduce the number of these deaths so we're gonna make driving illegal." So people can't drive cars they can't drive trucks anymore. 

Now let's think about the effects of this would be, okay first of all this would I think we could agree this would reduce the number of people who died from auto accidents. A lot of people who otherwise would have died in an automobile accident would now be alive. At least they wouldn't be dying in an automobile accident but this benefit that we get is not free. We have to give up something, right? There is an opportunity cost here we are giving up something to get the benefit of a lower number of automobile accident deaths.


So there are several things we can think about but I just want to give you some ideas so just the convenience of driving a car, let's say that you want to visit your family and your family lives in another state or and you can drive there very easily. You'll be giving up that convenience now sure you could maybe take a train or something like that but if you'd prefer to drive a car then you're giving up some convenience. We think about transporting goods, for example, transporting canned food and stuff when we have you know trucks and so forth that's in some cases the cheapest way of transporting goods to retailers, now we're gonna have to rely strictly on trains or other means of transporting goods and that might not be the cheapest way in some cases. 

That might end up having where we have to pay more for the things that we buy for a can of peaches there's something like that. We'd also be giving up potentially for some people, that's a way to get to work they get up and they drive to work maybe they live 22 miles away from their job and it's not convenient to walk or they don't have public transportation they live in a rural area. We'd be giving up that way and they'd have to find some alternative means to get to work or find a new job. Also, you can even think, well all of this is worth the health benefits of reducing the number of deaths from auto accidents, well what if you think about it like this we're also giving up a very quick way to get to the hospital in case of an emergency, for example, let's say that a woman goes into labor she's pregnant she goes into labor and says I'm gonna have a baby and we say well why don't you go stand at the bus stop and wait for the bus to get to the hospital? If you have a car you might just want to get in a car and go so you get a quick way to get to the hospital.


We're giving up all these things that are not to say that it's a bad idea or it's a good idea, it's just saying that the benefit is not free we're giving up all these things to get the reduction in the number of vehicle deaths. To get that benefit that we give up the thing that we're sacrificing, it's, in this case, multiple things that we're sacrificing we refer to that as the opportunity cost. The opportunity cost is the foregone benefit or forgotten value that we didn't get by choosing another action. Let's say you you're thinking about going to college or you're in college now or something that and so you think about your university education and what is the cost of that? 

Now people just tend to think of their university education in terms of tuition and books and stuff but let's pretend right now you're working in a job where you make $40,000 a year and you're thinking about doing a two-year MBA at a good college and they offer you a full-tuition scholarship. So you do not have to pay any tuition and let's say they pay for your books they pay for the whole thing and you say "Wonderful I can get a two-year MBA for free" but here's the thing, the MBA is not free and it's not free because to do this MBA now I'm assuming here that you can't work and do the MBA at the same time. So just say that it's a full-time MBA you'd have to quit your job. So to quit your job you're giving up two years of making $40,000 a year right and so we can take two and multiply it by $40,000 and then I'll tell you that there's $80,000 of earnings. 

You forego there's $80,000 of earnings, so you're giving up these earnings in order to do this MBA and so even if they pay a hundred percent of your tuition you're still giving up something. So eighty thousand dollars would be the opportunity cost for you of doing this to your MBA program.

Post a Comment

0 Comments