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A little bit more about opportunity cost

We've seen how opportunity cost is a concept that measures the cost of something in terms of what you have to give up to get it.

So what?

Well, the 'so what?' is that this becomes a powerful way to decide on a course of action. And it applies to individuals, companies, governments, you name it.

Here's a bigger example than concert tickets. Let's say that the government is able to come up with a value for human life. (In fact, this is itself a very difficult economic problem, but arguably a necessary one. At some point, I'll do a post on this.) Let's also say that we know how many people die each year of the obscure tropical disease 'Watford fever'. And we know how much it will cost to develop a cure for Watford fever.

Now many people would see this and would say that if the cost of the cure is less than the value of all those lives that would be lost, then clearly we as a country should pay to develop the cure. That's cost / benefit analysis isn't it? Well it is, but it isn't an _opportunity_ cost / benefit analysis.

Assume that the government doesn't have an infinite amount of money to spend (quite a reasonable assumption I think). And let's also assume that the government has other things it could spend money on (again, pretty reasonable). For the purposes of this example, let's not worry about budget deficits and government borrowing and that sort of thing. In fact, let's say that the one other thing that the government might spend money on is a cure for 'Reading plague'.

Hopefully at this point, you can start to see that the opportunity cost of developing a cure for Watford fever has to take into account not just the value of the lives of the people who would die from it but also the value of the people who would die from Reading plague.

An awful lot of government spending decisions can be boiled down to variations of this sort of analysis. And when you think about it, you make those sort of decisions in your personal life all the time, even if you aren't explicitly thinking in terms of opportunity cost.



( 4 comments — Leave a comment )
Sep. 9th, 2010 09:57 pm (UTC)
Now you're right into the territory of what my academic colleagues do at work.
Sep. 9th, 2010 11:43 pm (UTC)
Is that health economics or something more general?
Sep. 10th, 2010 06:02 am (UTC)
Basically health economics, yes, though we've also got a strong decision modelling element. The full name of the section is "Health Economics and Decision Science". So we have health economists, but also mathematicians specialising in OR, statisticians, systematic reviewers and so on.
Nov. 23rd, 2010 05:50 pm (UTC)
I have long thought that a value for human life is needed, uncomfortable though the subject is. It is more difficult to compare the value of, for example, subsidising cultural or sports events with the spending of that money *in a productive way* on improving the NHS.

Then there is the question of whether it would make sense to borrow, and solve *both* Watford fever and Reading plague this year, but then lack the funds to solve any further diseases that arise for several years.
( 4 comments — Leave a comment )