Could it not be said that there is almost always a more profitable way to invest a given sum of money or resources than the way in which these resources actually are invested? In that case, isn’t there almost always a higher missed opportunity cost to pretty much any investment? Without omniscience of all available alternatives for investment of a given sum of money, how can we gauge the true opportunity cost of any given action?
Opportunity cost is subjective.
Okay, but does this mean that if, say John Doe has a given sum of money to invest, and he only knows of three lines of production to invest it in (Line A, which will earn him a 1% return; Line B, which will earn him a 2% return; or Line C which will earn him a 3% return), and he invests it in Line C for the 3% return, while he has no knowledge of the existence of Line D, which, if he invested his money in it, would have earned him a 4% return, that he does not suffer a 1% loss because of the missed opportunity?
I think opportunity cost can only be determined between options that are known. However, I would like to read what other people have to say.
Okay, but you may as well count the fact that Mr. Doe could have walked into the local Kwik-E-Mart, slapped a dollar on the counter, played the number 4-17-23-31-39-42, and hit the lottery jackpot of $10 million. That’s quite a missed opportunity.
That’s what it would seem like to me, too. If that is the case, then why not go one step further? Instead of John Doe not knowing about the more profitable Line D, what if he does technically know that Line D exists, but he doesn’t know that Line D would offer a 4% return? Perhaps he has no idea that Line D would offer more than a 2% return, so he goes with Line C at 3%. Can he then be said to suffer a 1% loss due to opportunity cost if he had no awareness of the existence of a 4%-returnable line of production?
But, in that case, everyone already invests their money in that line of production that they know will offer them the most return. If they knew about the more profitable line of production, they would invest in it. So, with that in mind, opportunity cost would seem to lose all value as a meaningful component of cost-benefit analyses.
But, if opportunity cost is indeed objective rather than subjective, then there may really be no way to calculate true opportunity cost, because there might be (and likely there is) always a more profitable investment opportunity somewhere/somehow that the investor missed.
Why?
opportunity cost is an imagined cost.
when people consider their options they imagine what they will have to give up to get what they want, and will do this for the different options they see as available, this is a subjective process. it is not a comparison of actual costs, but of possible actual costs viewed psychologically from a subjective perspective. In contrast, an actual cost is having less after a time than you had before that time, as measured in a particular commodity, in an objective sense.
if someone declines to go to the race track and bet 1000$ on a horse, (for the subjective reason that they think that the odds are against the horse winning and they would rather not risk the possible loss, and would rather hold their money so that they could afford to go on holiday the next week). they do not break even if the horse loses, and lose if the horse wins. (as people who mmisunderstand opportunity cost mighty say).
The horse winning or losing incurrs no (real) costs on them at all. of course it might psychologically effect them in all sorts of ways.
so if you invest in some project, and after you earn a real profit, of 10$ gold dollars out for every 5$ you had put in, and someone comes to tell you you should have invested in some other project as those that did so get 20$dollars for every 5$, you have not lost dollars. to say that you have lost dollars is crazy.
Think of it this way, if I’m not willing to do the research to find out the other lines in which I can invest then the subjectively considered costs are too high and the profit is too low, otherwise I would do so.
So, you’re saying that the existence of the 4% returnable line (Line D) in my example should not be factored in as a merely 4% opportunity cost, but that the return from the 4% line, after discounting for the costs of finding out where it is, should actually be considered lower than the 3% line? Okay, that makes sense.
But if that’s the case, then how could opportunity cost ever be higher than actual revenue? Because one could just say that any more profitable investment that John Doe could have made was not actually worth it once it was discounted for the costs John Doe would have had to endure in going out of his way to research the unknown more profitable investment opportunity. For, if John Doe subjectively valued the ability to earn a 4% return in a line whose location he can’t yet pinpoint (after discounting for the psychic costs of doing all the research to find that 4% line) higher than he valued the ability to earn a 3% return in a line whose location he does know, then he would have bore the costs of all that research to find that 4% line and he would have actually found that obscure 4% line and made the 4% investment. But the fact that he didn’t means that the opportunity to make a 4% return was less valuable to him than the opportunity to make a 3% return. Thus, in making the 3% return rather than the 4% return, he suffers no opportunity cost that exceeds the revenue he got. Right?
I don’t understand what point you are trying to make.
Imperfect knowledge is a condition that people operate under. Of course, better knowledge of other available opportunities would lead to better allocation of resources. But if your idea is that opportunity cost is only a useful concept with perfect knowledge then you are wrong.
Okay, here’s my thoughts after letting the issue simmer in my mind all evening.
Obviously, opportunity cost must be subjective, because opportunity cost of a given action is the subjective value attached to the highest available alternative foregone for the sake of the action taken.
However, what I think I was overlooking here was the factor of time in calculating opportunity cost.
My whole line of thought here rested on the notion that the opportunity cost of a given action was ultimately calculated at the moment the action was undertaken. If the opportunity cost of a given action were calculated and set in stone at the moment the action was undertaken, then, no, the opportunity cost of a given action forbids the possibility that an action can ever result in a psychic loss, because the action taken is, by definition, always the most highly valued opportunity for action.
The opportunity cost of a given action, however, is calculated after the point in time in which the action was undertaken. After the fact, ex post, the actor decides whether the value he got from undertaking the action was higher or lower than the value he believes he would have gotten from any other alternative. In that case, subjective opportunity costs can be higher than revenue, thus resulting in “losses” due to failure to undertake a different opportunity for action, even if the rate of return the actor did get exceeded his time preference rate.
So, I think I answered my own question. I forgot to take into account the “time” factor.
Does this sound right?
does this provide any explanatory power?
How do you mean?
what can be explained by coining a concept that describes how people can feel (or claim to feel) disappointment about a past event? is this useful for understanding economics?
Well, the point I was trying to make was that: If opportunity cost is the value attached to the highest available alternative forgone, actors must make those valuations after the action has been taken, not at the precise moment the action is undertaken as I was assuming. Otherwise they’re merely forecasting, not dealing with actual costs, which I think I realize now can only be calculated ex post.
I believe my mistake earlier was my notion that opportunity cost was calculated at the moment the action is undertaken, rather than it being calculated after the action is taken.
It’s not just about “feeling disappointment.” It’s about comparing, after the fact, what desired end(s) could have been fulfilled (or unfulfilled) by undertaking a possible action with the desired end(s) that were fulfilled (or unfulfilled) by the action actually taken. That’s the purpose of judging opportunity costs, right?
the purpose is to decide what to do, so it is done before action.
I think you started out right and then convinced yourself you were wrong, and now maybe close to being wrong.
certainly information after the fact is good to inform future calculations of ways to approach goal achievement (i.e. the next opportunity cost evalutation), but thats it.
Well, people certainly attempt to forecast their opportunity costs (like any other costs) ahead of time, but the actual opportunity costs (like any other costs) only come into being (and can thus be really known) after the action has been undertaken, right?
its wrong to talk about opportunity costs ‘coming in to being’, since they are imaginary/subjective.
real costs come into being, when you pay out, or your materials depreciate.
if you wanted to commit to language about opportunity cost ‘coming in to being’, then you would say a series of opportunity costs came into being for you, when people kept coming into the room and telling you that you missed out on having gone hang out with them the night before, compared to your having stayed in.
If opportunity costs are judged at the moment the action is undertaken, then opportunity cost will never be higher than revenue, because an actor will necessarily always undertake the action that they believe at the moment the action is taken to be the most profitable.
If that’s the case, then Murray Rothbard’s definition of “profit” would be wrong. Murray defined profit as that income accruing to you over and above the market rate of interest, not that income accruing to you over and above your own individual interest rate (time preference rate). Thus, Murray would say that if you have a time preference rate of 2%, the general market rate of interest is 5%, and you only make a 4% return, you don’t make a 2% profit, but rather you make a 1% loss, because of the opportunity cost–the loss of the value of the best alternative (the 5% return) forgone.