What is Opportunity Cost?
“While shopping for my first stereo, I spent an hour debating between a $1,000 Pioneer and a $700 Sony. Perhaps fearing that my indecision would cost him a sale, the salesman intervened with the comment “Well, think of it this way–would you rather have the Pioneer, or the Sony and $300 worth of CDs?”
Wow. The Sony–and by a large margin. Twenty new CDs were too great a sacrifice for the slightly more attractive Pioneer. Although I could subtract $700 from $1,000 and was capable–in principle–of recognizing that $300 could be used to buy $300 worth of CDs, I hadn’t considered that until the salesman pointed it out.”
The problem is that the $300 in CDs given up by buying the Pioneer are not clearly the opportunity cost. Recall that the opportunity cost of something is the value of the highest-valued opportunity foregone. So the $300 in CDs are the opportunity cost only if the buyer had nothing better to do with the $300 than buy CDs. What are the odds that the salesman knew enough about the buyer’s preferences to know that?