The Opportunity Costs of Relationships

Since it is generally easy to compare the price-tag cost of one good or service against another, people tend to consider only the monetary cost of a decision. However, what’s also important to consider is the whole value of what you are giving up when you make a decision. In economics, this is known as the opportunity cost. A simple textbook example describes a market that offers two goods for sale: apples and oranges. If an apple can be bought for $1 and an orange for $0.50, the monetary cost of buying an apple is $1, but the opportunity cost is equal to how much you value the two oranges that you give up if you choose to buy an apple. While this observation may not seem particularly important in this context, it can be applied far beyond the realm of monetary dealings.

Romantic relationships are obviously not regular commodities like apples and oranges in that you don’t just head to your local date market and buy a girlfriend or boyfriend. Despite this violation of the competitive hypothesis, relationships have opportunity costs too. That is, the opportunity cost of a relationship is comprised of all the things one foregoes to be in that relationship. While it is not difficult to see the many wonderful things you gain from having a romantic partner, it is easy to overlook the things you give up in exchange.

Here’s a list of some of the things that most people forgo to some degree to be in a relationship:

(1) Spending time with friends and family
(2) Going out and meeting new people
(3) Developing or engaging in hobbies
(4) Working
(5) Exercising

Some people may find that being in a relationship allows them to do more of some of these things (maybe you work out together or spend lots of time with mutual friends), but usually the time you spend with your significant other tends to edge out at least some of the things you like to do on your own.

In economics we represent such trade-offs using graphs like the one below. The red line is known as the budget constraint, and while it typically represents a monetary budget, in this case it represents a sort of time budget for an individual in a relationship with eight hours of leisure time per day (assuming eight hours of sleep and eight hours of work). The eight hours of leisure can be divided anywhere between spending all 8 hours with your significant other or all 8 hours doing other things. Regardless of what allocation a person chooses on the red line, any movement along the line represents a tradeoff of one activity for another.

Despite the perception of economics as dismal science, the point is not that the cost of relationships outweighs the benefits, but rather that there is an opportunity cost to everything. So if you’re single and accustomed to thinking about all the things you’re missing out on, take comfort in the things that you aren't giving up.



Discussion Questions:

1. Consider the graph depicting the time-budget constraint. If a person quits their job and suddenly has more time, how does this affect the person’s position on the line or the position of the line itself?

2. If person A and person B primarily give up time spent with friends when they are in relationships, and person B really likes being with friends, which person’s relationship comes at a higher opportunity cost? If you were to draw each of their indifference curves on the budget constraint graph, how would the two compare?

3. How would being in a relationship affect your overall consumption? If you are in a relationship, are there some goods or services that you would consume more or less of in a given week? Which of these goods would you say are “complementary goods” with relationships? Which are “substitutes?”

4. Sometimes when economists model consumption choices for goods that are consumed over longer periods of time, they introduce switching costs. What sorts of things associated with a break-up may be considered a switching cost? If you assume that breakups are costly, how might this change a person’s decision to allocate their time?

Economics of Flu Vaccines

In the last few months, the H1N1 influenza virus, or “swine flu,” has been dominating the news, and many people are worried about access to flu vaccines or “flu shots.” (That is, unless you work for Goldman Sachs, who got first dibs. But don’t they always?)

Unlike other viral diseases, flu viruses constantly mutate, or change into new “strains.” A vaccine that works to protect against a specific strain one year will probably not work to prevent against a new strain the next year. Because of this, hundreds of hours of lab work are devoted each year to identifying specific flu strains, developing a vaccine against them, and then producing that vaccine in large enough quantities to distribute to the population.

This year, the efforts of flu vaccination labs have been split, with only some of the labs producing vaccines against the “regular” flu, and the rest working on vaccines against the specific H1N1 swine flu strain. Because of this, the supplies of both of these types of vaccines are greatly reduced this year in comparison to previous years.

Given the scarcity of both traditional and swine flu vaccines, how should the existing vaccine be distributed? If the goal is to maximize societal health, the flu vaccine should first be given to those whose health would benefit from it the most, who are people at risk of complications and death from the flu, including young children, the elderly, and the immuno-compromised. On the other hand, if the goal is to minimize the cost of the flu to an economy, the most productive and important members of society should get the first vaccine.

To a certain extent, extreme examples on both ends are small in number and easy to take care of. For example, health care employees are at greater risk of contracting any disease and, consequently, of infecting those whose health is vulnerable. So it’s clear they should be the first in line to get the vaccine. But what about people who don’t have such critical jobs (and keep in mind that you probably qualify as one of these people)? This topic relates not only to the health of the economy, but your personal health as well.

Discussion Questions:

1. Do you think that the goal of those who control flu vaccine policy should be to get the best health outcome, to minimize the cost to GDP, or some combination of the two? What public health policies would achieve your preferred policy goal?

2. Assume that society does want to maximize productivity in dollar terms rather than health outcomes. Now, take into consideration the fact that those who do get sick might require expensive medical treatment, the cost of which will be partially borne by society. How does this alter the analysis of who should receive the vaccines?

3. Economists often are fond of markets as allocation mechanisms because the forces of supply and demand determine a price that allocates goods to those who are willing to pay for them the most. How would a market for flu vaccine work? Why is it different from a market for non-life-affecting goods and services, like books or cars?

4. Firms (especially ones with high-productivity employees) value their employees’ health. It is estimated that that the total yearly economic cost of the flu in the U.S. is over $80 billion. Many companies have started to recognize this and have made attempts to protect their own economic interest by paying for or providing flu vaccines to their employees. As a result, employees who otherwise may not have been vaccinated (since the unsubsidized cost exceeds the expected health benefit) are more likely to accept the free vaccine. Is this efficient? Is it equitable?

5. Vaccines have a limited shelf-life – that is, they can only be used for a particular period of time if they are to be effective. For this reason, the timing of development, production, and distribution of flu vaccines in the United States is largely based on the pattern of the flu season in previous years. Go to Google Flu Trends to see a graph comparing the incidence of flu activity in the United States this year with previous years. How does the current flu season differ from previous years? If you were in charge of setting production policy for 2010, what might you change in order to produce the correct amount of vaccine for each strain of flu at the appropriate time?

Who Says There's No Such Thing as a Free Lunch

One of the most popular sayings associated with the “dismal science” of economics is “There’s no such thing as a free lunch.” The major idea behind this phrase is that even if you aren’t given a bill to pay, there is always an implicit cost associated with any action.

The economic concept supporting this statement is that of opportunity cost, which is defined as the best foregone alternative. Simply stated, it’s what you give up in order to do something else. Consider the following example: you have $10 that you can either spend on a movie or a pizza. The opportunity cost of going to the movie is therefore the pizza that you give up by attending the movie, and vice versa.

But what about when a good is free to consume? What is the opportunity cost in this situation? Usually in cases like this, the opportunity cost is associated with the value of your time or some other implicit cost. For example, if you work hourly, the time it takes to wait in line for a “free” offer is time that you could’ve spent working and earning money; “free” in this case simply means that there is no explicit monetary cost, but it says nothing about the implicit costs of waiting for the item. Another common example is when you receive a “free” weekend getaway, but the cost is that you have to sit through a 2-hour sales pitch with a timeshare organization.

I was thus astonished when I received something truly for free a few weeks ago at Auntie Annie’s pretzel shop. I was at the mall with my friend when the two of us realized we were getting pretty hungry. Wanting to avoid eating a fast-food meal at the food court, we decided to each grab a pretzel at Auntie Annie’s to hold us off for awhile. As we were waiting in line, one of the workers started giving out samples. My friend suggested that we try them since the line was pretty long and we were quite hungry. As I walked over to receive the samples and my friend stayed in line, the worker also instantly handed me a coupon: BUY ONE PRETZEL, GET ANOTHER ONE FREE. Having already committed to wait in line to purchase two pretzels before I got the coupon—it was my friend’s birthday so the two pretzels were on me—I actually received a free pretzel! After consulting with some other economists, none of us could find an implicit cost that I incurred in order to receive the free pretzel (though you could argue that my time to write this blog post is an after-the-fact cost associated with the pretzel purchase). In short, who says there’s no such thing as a free lunch?

Discussion questions:

1. Can you think of a time in your life where you actually received something for free? That is, there were no explicit monetary costs or implicit opportunity costs.

2. If I was just passing by Auntie Annie’s and received the coupon, why would the second pretzel not be free? What opportunity costs would be associated with using this coupon in that case?

3. Suppose you have a “Buy 10 pretzels, Get One Free” card for Auntie Annie’s. Does it distort your behavior in any way? Is the 11th pretzel actually free?

Scrooge's Economic View of Christmas

We all know how easy it is to get caught up in the Christmas spirit and gift-giving frenzy. A lot of time and energy is spent thinking of the "perfect gift" for friends and family. While I'm sure many are successful in this endeavor, there are undoubtedly a large number of gifts given that people would rather trade in for cash—even if that cash amount is less than the retail price of the good.

Thanks to eBay's anonymous online service, consumers can now do just that! According to a recent study from eBay, more people than ever will sell unwanted items this year. The ongoing recession is partly to blame: many people can probably use the cash from selling gifts to lower their credit card debt, pay their mortgage, or simply cover the bills. But people's general preference for cash to gifts can be explained using the economic fundamentals of utility.

Now that the holiday season has come and gone, many of us find ourselves thinking, "What will I do with another FM transmitter for my iPod?" Oftentimes, both the gift giver and gift receiver could be made better off (that is, receive a higher level of utility or happiness) if a cash exchange had taken place instead. To understand the economic rationale behind this, we turn to the basic consumer theory model of budget constraints and indifference curves.

Recall that an indifference curve maps out all the possible consumption bundles of goods that yield the same level of utility to a given consumer. Indifference curves tell us nothing about what we can afford, but rather how happy a particular bundle will make us. On the other hand, budget constraints show the consumption bundles that we can buy given our income and the prices of goods. Similarly, budget constraints say nothing about what we would like to buy, but rather what we can afford. A consumer's optimal bundle of goods is located where the budget constraint is tangent to the highest possible indifference curve.



But what happens to your budget constraint when you receive a gift? Consider the following simplistic example. You consume only two categories of goods: books and food. You have $80 each week to spend on these two goods. The price of a book is $10, and the price of each unit of food is also $10. Suppose that without receiving a Christmas gift, you would consume 2 books and 6 units of food. This is represented by the graph below:



But now suppose that your grandmother gives you 5 books for Christmas. This means that you can now afford 8 units of food and 5 books without spending any money on books, and you could afford 13 books if you don't spend any money on food. Assume that you cannot return or immediately sell the 5 books your grandmother has given you. If you have a high preference toward food over books, you may find that there is no indifference curve tangent to your new budget constraint in the region where you can now consume-between (4 books, 8 units of food) and (13 books, 0 units of food):



In this case, the optimal consumption bundle does not satisfy the tangency condition because there is no tangency in this restricted region of the budget constraint; we call this a corner solution. In other words, if instead your grandmother gave you the cash she spent on the books (5 books x $10 per book = $50), your budget constraint would also include the grey, dashed region below, and you would be made better off since you can now consume 3 books and 10 units of food.



Discussion Questions

1. How much money could your relative have given you, instead of the present, that would leave you at least as well-off as if you had received the present (that is, with the same level of utility)? Draw this on a standard budget constraint-indifference curve diagram.

2. What elements of real life does standard consumer theory ignore?

3. What gifts, if any, could your grandmother have given you instead of 5 books that would be just as good as if she had given you the cash she spent on them?

Honduras: Hosed by Sock Tariffs

In 1984, the U.S. government gave Honduras unfettered access to the American sock market. The move was the first of several trade deals that would ultimately unravel Fort Payne, Alabama's status as the sock capital of the world. Fort Payne's sock factories struggled to compete with the likes of Honduras, China, and Pakistan when it came to the labor-intensive step of seaming sock toes. American workers receive approximately 2 cents per seam (at about six seconds per sock, a good hour would bring in $12), but foreign workers sew for half of that. The labor savings add up over millions of socks. The cost disadvantage forced many Fort Payne sock mills to shutdown and lay-off workers.

Keep in mind that many people benefited from U.S. openness to trade in socks and other goods. Americans gained access to a wider variety of less-expensive goods—socks included. American firms and workers in U.S. export industries benefited from access to foreign markets. A cosmopolitan view also acknowledges the gains to firms and workers in developing countries. The Honduran sock industry thrived on access to the American market, generating more jobs and higher wages for workers. Of course, none of this is of much solace to a laid-off sock worker in Fort Payne.

A number of Fort Payne sock mills managed to hang on, but much of the town's industry consists of relatively new ventures, like bridge building and label making, with no relation to hosiery. As a recent two-part story (here and here) from NPR's Adam Davidson illustrates, Fort Payne's dynamic economy absorbed its losses from international trade—creating new, often better-paying jobs for many of the workers initially displaced by globalization. Even as Fort Payne's economy moved on, the political clout of the sock industry remained strong. Alabama congressman Robert Aderholt struck a deal with President Bush in 2005—Aderholt would support the Central American Free Trade Agreement (CAFTA) if the president agreed to re-impose tariffs on socks from Honduras. The president agreed; CAFTA moved one step closer to full implementation; and the administration gave itself a deadline for resurrecting the sock tariff—December 19, 2007. Read Davidson's report to learn more about the potential impact of rolling back free trade with Honduras.

Discussion Questions

1. How did sock tariff removal initially impact Fort Payne? How does the economy in Fort Payne look today? Would you characterize it as a sock dependent town?

2. How will the re-imposition of the sock tariff affect the historically small number of sock mills and sock workers in Fort Payne? How will the tariff affect sock mills and workers in Honduras? How will the removal of duty-free status for Honduras impact other developing countries, such as China, that currently face higher U.S. trade barriers than Honduras?

3. The president acceded to representative Aderholt on sock tariffs for Honduras in order to get a vote for CAFTA--a wide reaching agreement that has the potential to reduce trade barriers among multiple countries. Was the deal worth it?

4. Fort Payne's economy adapted to life with open trade, but not all workers experienced a smooth transition from the sock-based economy. According to Davidson's story, how have workers had to adapt to the new labor market in Fort Payne? What, if anything, is the appropriate role for government in easing the adjustment to globalization in towns like Fort Payne?

5. Think about the local, regional, or national economy. How would life be different today if everyone, everywhere were producing the same stuff that they were 30 years ago?

Can Economics Take the Guilt out of Conspicuous Consumption?

Looking at the world through economic lenses can often take the emotional charge out of otherwise controversial decisions. Take the environmental consequences of gasoline consumption. Instead of feeling guilty about driving a big SUV or thinking ill of those who do, why not take the approach suggested by this Time magazine article on carbon budgeting?

What if everyone in the country received the same number of pollution credits regardless of whether they owned a car? The question of who gets to pollute is reduced to a matter of who is willing to incur the cost. And people who do not own cars or who seldom drive benefit from their ability to sell their credits to those who need or want them. The next time someone passed you in a Hummer, you'd know she paid a greener soul for the right to do it.

Discussion Questions

1. How would the pollution-credit scheme change the tradeoff between driving and alternative modes of transportation?

2. Harvard economist Greg Mankiw advocates a gasoline tax for a variety of reasons, including environmental considerations. How is a pollution-credit scheme different from enacting a stiffer tax on gas? How would government enforce pollution-credit usage? Which system would require fewer administrative costs?

3. Critics note that stiffer gasoline taxes would be regressive. That is, a relatively rich person with a gas-guzzling SUV would still devote a smaller share of his or her income to gas taxes than a poor person with a fuel-efficient compact. Would a pollution-credit system face similar concerns?

Leisure? What Leisure?

Between 1890 and today, inflation-adjusted average income in the United States has increased by a factor of 8, while the average hours of weekly work have declined by approximately 20. That's good news: we earn more (a lot more) than we used to, and we do it with a shorter work week. People also start work later in life (less child labor, more college educations) and retire earlier. So, what are we doing with all of that extra time away from paid work? In his latest New York Times column, Hal Varian considers recent research that attempts to answer the question.

According to economists Valerie Ramey and Neville Francis, the decline in hours of paid work has not corresponded to an increase in leisure time—primarily because leisure is not the same thing as time away from paid work. So, what exactly is leisure time? The American Heritage Dictionary defines leisure as freedom from time-consuming duties, responsibilities, or activities. But even this definition is vague: aren't all activities—including pleasurable ones like reading, sex, sailing, hiking, or watching TV—time-consuming?

The economists offer their own definition: leisure activities are those that provide direct enjoyment. Under this definition, undesirable and unpaid work we do on our free time (like taking out the trash) does not count as leisure. So what does? Read Varian's latest column to see how Ramey and Francis categorize leisure activities and why their research suggests that leisure time today is about as plentiful as it was in 1890.

Discussion Questions

1. In 1910, how many male children 10 to 15 years old were employed full-time? How many 14- to 17-year-olds were enrolled in high school? What's happened to teenage enrollment rates over time? What about the leisure time of children and teenagers?

2. How do Ramey and Francis determine what activities provide direct enjoyment? What about non-paid activities, like child care, that involve both pleasant and unpleasant aspects?

3. How have advances in technology affected the amount of non-paid housework we choose to do? There's a tradeoff between non-paid housework and leisure. What do the choices we've made about housework over the past century suggest about the value of additional leisure time compared to the value of additional nutrition, health, and cleanliness?

4. Have job characteristics changed over the past century? Have jobs become more pleasant (or less unpleasant)? What about non-paid housework? Ramey and Francis contend that the amount of time we devote to purely enjoyable activities hasn't changed much over the past century. In what ways has the time we spend on paid and non-paid work become more (or less) enjoyable?

5. Steven Landsburg discusses leisure in his latest Slate column.What's been happening to the distribution of leisure time since the 1960s?

Quality, Choice, and Growth

Two articles in the New York Times this week are nicely complementary. Each looks at long-term trends in the U.S. economy, and in particular what Americans have chosen to spend their money on as they became progressively richer over the past few generations. And each argues that quality improvements have been a major force in driving American consumption patterns.

In the first, David Leonhardt argues that Americans face a tradeoff between better health care and other consumption goods. While he states that the health care system is indeed in crisis, he doesn't worry that increases in health care spending outpace inflation. We get what we pay for, in his view; and although Americans now pay, on average, $5,500 more per year on health care than they did in the 1950's, that's a small price to pay for the increased quality of life we now enjoy.

Robert Frank makes a similar point in an article titled "The More We Make, the Better We Want." He points out that we could now afford the lifestyles of our grandparents with only a fraction of our current income, but we choose not to.

Both articles illustrate a central element that drives economic growth: the insatiability of human desires. When Adam Smith wrote The Wealth of Nations, it was an easy argument to suggest that scarcity is a defining principle of life -- for one thing, just getting enough calories to survive was a challenge for a majority of people. But in an era when obesity is a bigger problem for Americans than hunger, it's reasonable to ask why we continue to work so hard. In the words of Keynes (that Frank quotes), "A point may soon be reached, much sooner perhaps than we are all aware of, when these needs are satisfied in the sense that we prefer to devote our further energies to noneconomic purposes." Clearly that point has come and gone, and yet here I am at work. Why?

Frank argues that the answer to this question lies in the understanding of what "basic needs" are. A theme running through much of his work is that people define their needs in relative terms, rather than absolute terms. Thus everyone might want a "good house in a safe neighborhood," but that might mean something very different in Los Angeles than it means in Baghdad. If the rest of society is driving a Camry, then, almost nobody is going to be happy driving a Model T.

Leonhardt argues that the answer to this question lies in the fact that technology--and in particular, medical technology--extends the boundary of what is possible. Living a healthy, full life means something very different in 2006 than it did in 1950, but taking advantage of modern medicine costs money.

1. Suppose you're in the market for a car, and you know that you want something like a Honda Civic. You come upon a brand new 1980 Honda Civic that had never been driven. You could save a lot of money by buying that car rather than a 2006 Civic. You work an hourly job and can choose how many hours you work. Suppose that if you bought a 2006 Civic and worked for 40 hours a week, you could afford to spend $400 per week on other goods. If you bought the 1980 Civic, you could either choose to still spend $400 on other goods and work fewer hours, or you could continue to work a full 40-hour week and spend more than $400 on other goods. Which of these options would you choose?

2. Suppose you meet a genie who offers you a choice: you can live in the 1950's and earn more than 90% of people, or live in the present and earn the average wage. Which would you choose? What if it were the year 1900? Or 1500? (Before you answer, you might want to pause and think a moment about indoor plumbing.)

3. Suppose a medical research project could extend life expectancy from 80 to 100 years. How much should we, as a society, be willing to pay for that project? What about one that extended life expectancy to 120 years? Or 140? Perhaps an easier question to answer might be: how much would you be willing to pay to extend your own life expectancy? What current consumption would you give up to live an additional year?

Baby Bonus Blunder?

Australians live longer and have fewer children than they used to. In fact, most of the 30 countries in the Organization for Economic Co-operation and Development (OECD) show the classic signs of ageing: rising life expectancy and falling fertility rates. Life expectancy at birth measures the number of years an average person in a population can expect to live. The fertility rate for a population is the average number of childbirths per woman of child-bearing age. Longer life expectancy and lower fertility rates mean that retirees make up a larger share of OECD populations. The graphs below shows the OECD's estimates and projections for life expectancy and the fertility rate.


In OECD countries, retirees receive public benefits, like Social Security or Medicare in the United States, that are financed with taxes from active workers. As a population ages, the ratio of retirees to workers rises--the pool of beneficiaries expands as the tax base shrinks. The pressure on public finances in OECD countries will continue to rise unless the countries adopt policies that raise tax revenues or cut benefits. A host of possible solutions exists, not all of them politically palatable: increasing taxes on workers, cutting retiree benefits, increasing the retirement age, or opening borders to more immigrant workers.

In 2004, the Australian government tackled declining fertility rates head on with a cash-for-babies policy. In May of 2004, the government announced Australian parents would receive A$3,000 (US$2,200) for newborns delivered on or after July 1, 2004. Time will tell whether Australia's baby bonus is large enough to noticeably increase fertility rates, but economists Joshua Gans and Andrew Leigh found that the baby bonus announcement had a big impact in the short term (download their research paper here). How do you think Australian parents with late June due dates responded to the government's announcement? Read Gans and Leigh's opinion piece in The Australian to find out.

1. On which day during the past 30 years were the most Australian babies born? Why?

2. According to Gans and Leigh, roughly 1,000 births were moved as a result of the 2004 baby bonus announcement. Of those, how many births were moved by more than three weeks? How is it possible to postpone births? How did the baby bonus announcement affect Australian maternity wards?

3. Despite the evidence of delayed births resulting from the 2004 announcement, the Australian government recently announced that the baby bonus will rise to A$4,000 on July 1, 2006. How, according to Gans and Leigh, should maternity wards and expectant mothers cope with the transition to the higher bonus? What can the government do to avoid similar disruptions in the future?

4. The rapidly expanding career opportunities for women in OECD countries present would-be moms with tougher trade-offs. Take a career detour to raise-up kids or continue pursuing the corner office? We know that the baby bonus announcement has a big reshuffling effect on birth dates in the short term, but its long-term effects on the kids-career tradeoff and fertility rates are less certain. Do you think Australia's baby bonus will offset a significant portion of the opportunity costs of childbirth faced by working women?

5. Can you think of other policies that would reduce the ratio of benefit-receiving retirees to tax-paying workers? Should the retirement age rise with life expectancy? How would more open immigration policies affect the ratio of retirees to workers? How would more immigration affect racial inequality if immigrants are of a different race than native-born workers?

Topics: Incentives, Trade-offs, Ageing populations