Opportunity Cost And Markets

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At this point, however, you might well say: "Now I'm totally confused. First I learned that price is a good measure of true social cost in the marketplace. Now you tell me that opportunity cost is the right concept. Can't you economists make up your minds?" Actually, there is a simple explanation: In well functioning markets price equal opportunity cost. Assume that a commodity like coal is bought and sold in a competitive market. If I bring my ton of coal to market, I will receive a number of bids from prospective buyers: $25. 02, $24. 98, and $25. 01.

These represent the values of my coal to, say, and three electric utilities. I pick the highest — $25. 02. The opportunity cost of this sale is the value of the best available alternative, that is, the second-highest bid at $25. 01 — which is almost identical to the price that is Cartier Santos Replica accepted. As the market approaches perfect competition, the bids get closer and closer until in the limit the second highest bid (which is our definition of opportunity cost) ...
... exactly equals the highest bid (which is the price). In competitive markets, numerous buyers compete for resources to the point where price is bid up to the best available alternative and is therefore equal to the opportunity cost.

Opportunity Costs outside Markets. The concept of opportunity cost is particularly crucial when you are analyzing transactions that take place outside markets. How do you measure the value of a road or a park, of a health or safety regulation? Even the allocation of student time can be explained using opportunity cost.

The notion of opportunity cost explains why students watch more TV the week after exams than the week before exams. Watching TV right before an exam has a high opportunity cost, for the alternative use of time (studying) would have high value in improving grade performance. After exams, time has a lower opportunity cost.

Say the federal government wants to drill for oil off the California coast. A storm of complaints is heard. A defender of the program states, "What's the entire ruckus about?

There's valuable oil out there, and there is plenty of seawater to go around. This is very Low-cost oil for the nation. In fact, the opportunity cost might be very high. If drilling leads to oil spills that spoil the beaches, it might reduce the recreational value of the ocean. That opportunity cost might not be easily measured, but it's every bit as real as the value of oil under the waters.

Opportunity cost, then, is a measure of what has been given up when we make a decision. The crucial point to grasp is this: Economic costs include, in addition to explicit money Tag Heuer Carrera Replica outlays, those opportunity costs incurred because resources can be used in alternative ways.

We have already encountered many examples of market failure or the breakdown of competition. We have seen that wages are often rigid in contrast to the minute-to-minute flexibility of competitive auction prices seeking their equilibrium. We have seen that two equally skilled people may work for different wage rates at similar jobs. We have seen how oligopolies and monopolies can restrain quantities to raise prices and profits. We witness environmental problems like the greenhouse effect and informational deficiencies that muddy the market for medical care.