Think Like an Economist: Opportunity Cost
Introduction
The article, “Economists, discover miracle hangover cure: drink less” proposes a method that can cure hangovers by economists written by Jessica Irvine, telling a story about Chris who is a rational person, making a decision on whether to drink an extra beer or go home by weighing the benefits and opportunity costs. Ends up with an outcome that there will be no hangover if economists rule the world under some vital assumptions.
Assumptions
There are three basic assumptions in this article that economists use to build the model.
1. Scarcity of resources.
People will allocate their resources properly and efficiently due to the fact that there are limited resources to satisfy their desires. Economists assume that people will allocate their resources so as to make individuals better off rather than worse off under the condition that people understand the consequence of behaviors as well as weigh the benefits of that particular behavior against the cost due to the shortage of resources.
2. People are rational individuals
Rational human beings will always want to maximize utility. Economists assume that people are all rational individuals that they understand that whether their utilities will be maximized by consuming a particular commodity or not by considering if the opportunity cost of the action is worth the benefit. By assuming that all humans are rational individuals who want to make their consumption choices to maximize their happiness or utility, they will consider not only the cost of their actions but also the opportunity cost of their actions.
3. Nonsatiation
People always prefer to get benefits more than less. If both commodities can bring people's satisfaction but in different levels, people without satiation would certainly prefer the one with higher benefit while others would not be caring too much. It is one of the preconditions assuming people all have different desires that are varied in importance and intensity so as to weigh and make choices.
Assumptions make a better understanding of behaviors while humans tend to change behaviors frequently and conditions vary. It is impossible for economists to isolate individual variables, so it is important that economists use assumptions to create a model with some certain consistency and also break down one complex process with plenty of information into portions. Assumptions simplify the conditions and processes by getting rid of interference and not considering unnecessary or least important factors while keeping the most important conditions which are involved. Also, ease the process when applying later to more complex studies as a general behavior of people.
People who use the model need to have a full understanding of what the preconditions and situations are to avoid subjective guesses. For example, what one rational individual would behave when facing consuming decisions while one can give oneself satisfaction, but the other one only makes things worse.
Opportunity cost
Under all the assumptions including that Chris is rational, he clearly understands that one more extra beer will be resulting in having hangovers the next day which would undermine his ability and enjoyment to accurately catalog his stamp collection. Also, forgoes the pleasure of playing the new PlayStation he bought and has always wanted to play through the week. The opportunity cost for him to go home and play PlayStation is a good feeling and pleasurable experience he will achieve by getting an extra beer.
Jessica’s Statement
As Jessica states, it is not always possible to be aware of the consequence of every action they take before people put into practice. Circumstance sometimes affects the result of how people choose even though they may have had a similar experience before. Humans are not very good at factoring opportunity costs and rarely calculate the way economists do when making decisions. As in the model that we assume that people always prefer more to maximize their utilities rather than less based on rationality, but not every ordinary human will meet the model. As said in the title and introduction, there will not be hangovers only if when people think in an economical way or follow the rule they made. But the fact is there are too many variables on individuals that will affect the way people think and act and the outcome of the model, where assumptions are necessary. In this case, many people may only think about “drink or not” and rarely related to all the costs that are involved in making decisions. Especially, when in a situation that they have companies, people are emotional and simply prone to herd behavior. They would like to enjoy more in a short time, so they tend to keep getting drinks and last the atmosphere and do what other people do without consideration.
Nevertheless, this statement is not necessarily true. Hangovers will still happen when people are rational. When people do not or barely have other choices, for example, a day free tomorrow without any plan but only sleep in and stay by oneself. This is a case that people do not have to worry about the opportunity cost regarding the alternative choice that hangovers will happen. In another case, let's say a young man has just broken up with his girlfriend and he feels so sad. Then he stays in the bar till late at night and kept drinking. He thinks he will temporarily forget about this by making himself drunk and will not be suffering. In his point of view that the opportunity cost of drinking is much smaller than the benefit it brings to him. Compare to the sadness, the pleasure, and nice sleep that drinking brings to will potentially make him choose to drink even then the opportunity cost of drinking can only last until the next morning.
Rational people usually weigh and assess marginal benefits they can get and marginal costs the need to pay between the alternatives. Individuals take into account not only the upfront costs but also the opportunity cost of the particular action before they make the decision. Ideally, people will take action only when the benefits are greater than the costs. In this case, the marginal benefit for Chris is the pleasurable experience and good feeling if he takes another beer while the opportunity cost is that he will not be enjoying cataloging his stamp collection and his newly bought PlayStation because he would feel sick tomorrow. Obviously, by getting another drink and feeling hungover tomorrow or saying having an increase in quantity results in a lower marginal benefit than the cost. Therefore, Chris decided to go home. The change of choices for rational people can be told from changing the opportunity cost. The example mentioned in the article as well is ‘only keep drinking if the additional pleasure from next drink outweighs the increased like-hood of a hangover the next day.’
‘It might work in theory, but it doesn’t work in practice’
Yes, it is. In reality, the assumptions made by economists are not always working. Most of ordinary people do not think like an economist and weigh the benefit to costs before they decide to an extra drink. Usually, people think in a simple way that seeing it only as a “to drink or not” problem. Models may not be fit to the accurate situation of reality. Being contradicting to the predictions, conditions may not be met due to complex factors. People are not able to analyze through different factors when doing decision-making under a particular environment. Thus the model will not work in practice as there are many variables on individuals and the environment.
Conclusion
In conclusion, the article states that there will be no hangover in the world under the assumption that if human beings are all rational or think like an economist. Nevertheless, this is a case that it might work in theory but doesn’t work in practice. Rational individuals are able to weigh between benefits and costs when making decisions to maximize their utilities. In fact, ordinary people will be affected by many variables and are often not very good at factoring in opportunity costs. Meanwhile, the unpredictable environment often limits people’s ability to think beyond the actions.
Reference
- Salvatore, D., & Salvatore, D. (2011). Microeconomics. New York: McGraw Hill.
- Huffaker, R. (2015). Building Economic Models Corresponding to the Real World. Applied Economic Perspectives & Policy, 37(4), 537-552
- Irvine, J. (2009, October 3). Economists discover miracle hangover cure: drink less.Sydney Moring Herald.
- Gans, J., King, S., Stonecash, R. E., Byford, M., Libich, J., & Mankiw, N. G. (2014). Principles of economics 6th edition. Melbourne: Victoria Cengage Learning Australia, pp. 3-7.
- Anderson, D. Marginal Costs & Benefits. The environmental literacy council. Retrieved from https://enviroliteracy.org/environment-society/economics/marginal-costs-benefits/
