Evaluate opportunity costs in the decision making

Opportunity cost is a subtle concept that requires careful analysis to implement. Even trained economists can make mistakes if they are not careful to include all relevant costs in the analysis. Two researchers from Georgia State University (P. Ferraro and L. Taylor) posed the question to 200 professional economists at an annual meeting.

A careful application of the definition of opportunity costs yields a clear answer-$10. The next best alternative use of your time, going to the Bob Dylan concert, produces a net benefit of $10 (the $50 value you place on the Dylan concert minus the $40 to purchase the ticket). Marginal analysis implies that you should go to the Clapton concert as long as you obtain at least $10 worth of happiness from the concert. For example, if you value the Clapton concert at $15, you are $5 better off going to the Clapton concert than the Dylan concert, which yields only $10 of net value. Interestingly, only 21.6 percent of the profes- sional economists surveyed chose the correct answer, a smaller percentage than if they had chosen randomly. Additional surveys revealed that the incorrect answers were driven by faulty analysis and not by the specific wording of the question. College students who had taken a course in economics did even worse.

The lesson is that managers, students, and even economists should be careful to include all of the relevant explicit and implicit opportunity costs in their analyses. Missing a hypothetical question on opportunity costs is inconsequential. Managers can destroy significant value if they make mistakes in evaluating opportunity costs in their decision making.

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