The Hindu Business Line : Opportunity cost: The varied implications and complications

ON APRIL 5, we had a great visual and emotional feast — the ODI — in Visakhapatnam, the city of destiny. Thousands thronged the stadium and watched the match live. Many more across the country were glued to their TVs, watching the match live. Since India emerged victorious, there was jubilation and celebration. For the audience the match had far greater value than anything else they could have otherwise done with their time.

Each spectator exercised his or her choice after considering, what is known as, opportunity cost. The principle of opportunity cost can be explained as follows: Consider a rational individual who has two options on how she can spend a three-hour interval between 6 p.m. and 9 p.m. on a particular day. She could either go for a movie, which of course would involve paying the ticket price. Or, she could attend a free dance programme. On the face of it, an impartial onlooker making a direct comparison of the alternatives would advise her to opt for the dance programme. If the consumer, however, were to decide on going for the movie, it is an indication of her relatively strong preference for the movie. The lost opportunity (dance programme) has lesser value for the consumer than the movie, within the given framework.

A mega hospital located close to a railway station, a high-rise residential complex next to an airport and a cinema hall near a high school are examples where the decision-maker has not taken into account of all the feasible uses of the land in question and has scant regard for the opportunity cost. Instead of the hospital there could have been a budget hotel for tourists; land near the airport could have been reserved for future expansion of the runway; and a public library-cum-cultural theatre would have better suited the land near the school. Every activity requires the use of `scarce' resources. Resources have alternative uses. The cost incurred in terms of a forgone opportunity is defined as opportunity cost. It is the true cost and differs from the accounting cost.

Elected leaders routinely decide on the location of international airports, software parks, industrial estates, central universities, the IIMs, the IITs, etc. There is hardly any public debate or discussion on the alternative uses for a given locale or alternative locales for a given project, or the attached accounting costs involved in the development and use of the facilities.

The manner in which ministers allocate land for institutions, in the name of development, often gives the impression that there is little or no land cost involved, especially when that land may not be in use. The `no cost' idea is but an illusion as there can be opportunity costs attached to it. Ask the villagers nearby if they would like to have a large tank dug at the spot in order to store water and their answer would provide enough scope for the computation of the opportunity cost, which is the real (hidden) cost.

A straightforward method of finding the opportunity cost of using a resource, such as land, in a certain way, is to evaluate the next best use that the resource can be put to. Good governance is to publicly state all the reasons justifying the choice of a location for a project. Good governance, in addition, would include stating details of owners of land along the route to the proposed airport location. Those owners — a special interest group — may be a strong force in artificially proving that the opportunity cost involved in the choice of location is not much.

The credit for the formal introduction of the concept of opportunity cost in the last quarter of the 19th century goes to the Austrian economist, Friedrich von Wieser. It gained recognition (and of course, critical evaluation) as other economists in Austria and elsewhere contributed to it.

In the context of buying goods and services, a rational consumer would buy a product if she believes it's worth it. The worth is evaluated in terms of something else that has to be given up. Exchange is facilitated by individual evaluation of relative desirability of different goods and services. At the end of it all, what people demand is what markets produce and the intensity of demand is an important determinant of the market price.

It is not as if one and all have unquestioningly accepted the principle of opportunity cost. There was an intense debate on the issue, notably between the British and the Austrian schools.

To illustrate some of the powerful implications of the concept of opportunity cost, consider the case of rural boys and girls not attending school on account of having to contribute on the farm and the kitchen respectively. Is it not fair that the governments compensate the parents' loss of real income when children are taken off farms and kitchens to attend school? The issue is taken care of by way of incentives in the form of free uniforms, books, transport, mid-day meals and so on. On the top of the income in kind, if the school and teachers are attractive to the pupils, within a short while, we will see rural India bubbling with schools full of healthy and happy school children.

It is important to mention here the simple fact that every individual applies the concept of opportunity cost in making decisions. This indicates that the term `decide' has its root in the Latin word decidere meaning "to cut off". It can be interpreted as cutting off all less significant alternatives.

At the time of the ODI, people waited in line at some of the traffic junctions in the hope of a glimpse of the stars. There was no possibility though, as the bus in which the cricketers sat had tinted glass windows. Each on-looker must have considered the opportunity cost and decided that there was nothing better to do with their time than to wait at the junction and take a chance.

The interval between birth and death is the length of life made up of days, hours and minutes. What one does with time and hence life is far too serious a matter to be ignored. `Time wasted is life wasted,' is the simplest and best summary of the principle of opportunity cost.

(The author, formerly with the National University of Singapore and the World Bank, is Professor Emeritus, GITAM Institute of Foreign Trade, Visakhapatnam. Feedback may be sent to bhanoji@gmail.com.)

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