Costs, Cancer, and Making Better Choices
By Steven Horwitz
You might think economists are obsessed with the idea of “cost.” It is nearly impossible to talk to or read economists without our invoking cost for some reason or another. This is, however, not some irrational obsession on our part. The concept of cost is at the very heart of economics. It comes into play in almost every type of analysis or topic of discussion in which economists engage.
Applying the economist’s concept of cost can also be incredibly useful for much of our everyday thinking. A sound understanding of the interrelated ideas of opportunity cost, marginal cost, and sunk costs can provide important guidance in navigating almost any situation of choice. Even those that we don’t think of as economic.
In this article, I want to explore economists’ conception of cost; I will emphasize three points. First, the fact that we live in a world of scarcity means that every choice we make has a cost. Second, cost is ultimately about our expectations and therefore resides in the realm of the subjective. Putting these first two observations together leads to my third, and perhaps most important, point: cost is always forward-looking. Past events that we cannot change are not relevant costs when we make a choice.
The idea of sunk costs is particularly important in our everyday decision making. I want to explore it by talking about the role that anger and other emotions can play by interfering with the choices we make, and how understanding sunk costs and the forward-looking nature of choice can make it a little bit easier to overcome them.
Almost every introductory economics course begins with the fact that we live in a world of omnipresent scarcity. For economists, scarcity is not a physical concept—it is not the same as “rarity.”
We can illustrate by borrowing an example from the textbook The Economic Way of Thinking. To the best of my recollection there are, at most, two Steve Horwitz autographed baseballs in existence. This makes them exceedingly rare. The number of Derek Jeter autographed baseballs is significantly larger. It’s tempting to think that the Jeter baseballs are less scarce than the Horwitz ones. Unfortunately for me, many people think a Jeter autograph is very desirable, but not even my dad would want a Horwitz autographed ball. That means it’s the Jeter baseballs that are scarce in the sense that economists use the word.
For economists, scarcity means that people can imagine more possible ways in which they can put a good to use than there are goods that can be used. The greater that gap, the more scarce something is. Thus, the Jeter baseballs are scarcer than the Horwitz ones.
Because we have neither the time nor resources to satisfy all of our wants, we must choose which ones to satisfy. Therefore, every choice we make means giving up something else. I can spend the next hour at the gym or grading papers. I can spend next Thanksgiving at my family’s house or my wife’s. I cannot do both—I have to choose. Scarcity is omnipresent.
The cost of any choice can be understood as what we have to give up when we choose which want to satisfy. The “opportunity” in opportunity cost refers to the opportunity we forgo when we choose one thing over another. In the examples above, the opportunity cost of going to the gym is grading papers. The opportunity cost of Thanksgiving with my family is Thanksgiving with my wife’s family. And vice versa. But this is not quite precise enough. Really understanding opportunity cost requires a bit of a digression.
Another early topic in introductory courses is the idea that economic value is subjective. We mean this in a couple of ways, but the most important insight is that value is “created by the subject.” What gives goods value is not something inherent to the good, but that people believe that it can satisfy their wants. People are willing to sacrifice money for a Big Mac because they believe that it will satisfy their hunger, not because Big Macs are uniquely valuable. It is the belief that they will give us something we want that leads us to give goods value and therefore makes us willing to sacrifice for them. We, as subjects, give value to the objects of our action.
The subjectivity of value also means that the same physical object will have different value to different people—different subjects. If you’re a vegetarian, we will value the same plate of chicken wings very differently. When we talk about value subjectivism, differences across people and the fact that it’s difficult to compare our value assessments is what’s often emphasized. While it is certainly important, it’s only a consequence of the more fundamental subjectivist insight—the fact that goods have any value at all is a result of the fact that we, as actors, create it.
So what does the fact that actors create value have to do with developing a more subtle understanding of opportunity cost? Remember that value is based on the belief that a particular good will satisfy a particular want. When we make a choice, we are choosing into an unknowable, but not an unimaginable future. Economic choice is about choosing between various expectations.
In the moment that we make a choice, we compare our evaluations of different future states of the world: the one in which I choose one option and one in which I have chosen another. My evaluation of those possible futures is based on my expectations about how well either option will satisfy the relevant unfulfilled ends.
Think about yourself at a restaurant. When you decide between a steak dish and a pasta dish, you’re deciding between your expectations of how well each dish will satisfy your hunger. Looking at the menu is like being at a fork in the road. You have to make your best guess as to what each path forward will look like. Choosing one entrée over the other means having to persuade yourself of the accuracy of your own expectations about each dish.
Choice is as much about “getting over” something as it is about giving it up. What we really do when we choose steak over pasta is as much “getting over” our expectation of the deliciousness of the pasta as it is giving up what the pasta tastes like. Human choice is a process of getting over the mental hurdle of having to decide that is forced on us by scarcity. It is the act of persuading ourselves about the superiority of one of our alternative visions of the future.
Once we recognize that it’s all about expectations, we understand more completely that choice, including opportunity cost, is forward-looking. And because it’s forward-looking in this way, we never really know what our opportunity cost was. Put differently, how can we know exactly what it is we gave up when we have given it up? When I decide between steak and pasta for dinner and choose steak, I never know for sure what my opportunity cost was because I gave up the pasta (assuming I do not have a dining companion who orders it and gives me a taste). When I go to class instead of sleeping in, I don’t know for sure what I gave up because I didn’t sleep in. I might have had great dreams or terrible nightmares. I might have slept soundly or been awoken by a fire truck.
So to be more precise about opportunity cost, we might define it as the foregone expected subjective utility of our next best option. As Deirdre McCloskey likes to say, economics is what happens between your ears. The fundamentals of cost and choice are an excellent example of that aphorism.
Understanding the forward-looking nature of cost also helps us think about the idea of marginal costs. For economists, “marginal” means something like “the next thing.” So the “marginal cost” of something is the cost associated with obtaining the next unit of it. In a “buy one, get one at half price” sale, the marginal cost of buying a second $50 pair of shoes is $25. The total cost of two pairs of shoes is $75. Notice the difference between “a second” and “two” in comparing marginal and total costs. Marginal cost is the cost associated with moving forward (“a second”), while total cost looks backward at all that we (will) have spent (“two”).
From this perspective, opportunity costs and marginal costs are two different ways of looking at the same phenomenon. The marginal cost of the second pair of shoes is the $25 they would cost, and that’s ultimately understood in opportunity cost terms as the expected subjective utility of the next best use of that $25. Marginal cost looks at this in terms of a change we might make to our current situation, while opportunity cost looks at what we imagine we were giving up as we make that change. But both describe the same act of choice.
As Heyne, Boettke, and Prychitko put it in The Economic Way of Thinking: “All opportunity costs are marginal costs and all marginal costs are opportunity costs” (page 79, 13th edition).
Because choice, and therefore cost, is forward-looking, past choices that cannot be altered should be irrelevant to our current decision-making process. To take another example from The Economic Way of Thinking, imagine we place a $5,000 non-refundable deposit on a venue for our wedding. Now suppose we are considering canceling the wedding. What would be the cost of canceling?
The cost, from an economic perspective, is what we give up going forward with the decision to cancel. That does not include the cost of the venue rental, because no matter whether we get married or not we’re out the $5,000. That choice has already been made and is irreversible. It has become what we call a sunk cost. Because sunk costs cannot be changed going forward, they are not relevant to the next decision.
For another example, consider car repairs. Suppose I spend $400 fixing my car only to discover a month later that I need an additional $700 in repairs. In deciding whether to spend this $700 on repairs, the $400 I’ve already spent is irrelevant. I spent that already, and I can’t get it back. The question I’m facing is whether it’s worth spending the $700 on this repair. Economic thinking tells us that thinking “well, I’ve already put $400 into it…” is a mistake. The prior $400 might be informative in deciding not to purchase that model of car again, but it’s not relevant to the question of the next repair.
For the bride and groom in the wedding example it will be hard to ignore the $5,000 already spent, but it’s the economically correct way of considering the decision. They should consider the imagined subjective importance of loss of the gifts, the disappointment of their friends, or anything else that is part of the expectation of what will unfold in each of the alternative scenarios in front of them. They might even learn a lesson about the perils of non-refundable deposits. But what cannot be changed now cannot be a cost of moving forward. Choice is about what we will do next.
Don’t get angry. Think like an economist.
This rich concept of cost, which so captures economists, can make it much easier to deal with a whole variety of decision-making situations. It helps explain why poker players say, “Don’t throw good money after bad.” It explains why if you oversleep into an important meeting or a class you shouldn’t say, “Well I missed half of it, so I might as well go back to bed.” Sunk costs are sunk. You can’t get that half of class back, so considering that should be irrelevant to your decision moving forward. But you can make the second half. The question is always forward-looking and marginal: “is it worth it for me to go to the rest of class, compared to what else I could do with that time?”
The forward-looking model of decision making that helps us understand cost can help us in other circumstances, too. Thinking on the margin and recognizing the irrelevance of things we can’t change for future decisions can also help make better decisions in heavily emotional contexts. Folk wisdom understands this: “It’s no use crying over spilt milk.” Note that this saying is phrased in terms of “use.” Getting upset over what cannot be changed isn’t useful. An emotional reaction to what we can’t change might be cathartic or feel good in other ways, but it can’t change the past and is probably not helpful for changing the future.
I have struggled with this in the last few months. Just after getting married and starting a wonderful new job, I received a cancer diagnosis. I want to be so angry. There’s a cosmic injustice here that I just want to scream at. But every time I feel myself getting angry, I remind myself that all the anger in the world doesn’t turn back time or stop cancer cells from dividing and growing. The fact that I have multiple myeloma, for decision-making purposes, is importantly like a sunk cost.
To be consumed by anger at my disease would be to fall for the fallacy that sunk costs matter. Wasting my time and energy being angry about it does nothing. The question is, as always for economists, how do I move forward given the place I find myself? Anger is backward-looking. Figuring out what I can do to beat cancer is forward-looking. What matters is taking every pill, making every appointment, and learning more about how to treat my disease. That is what has kept me healthy, not being angry at the universe.
It doesn’t have to be economic costs and it doesn’t have to be cancer for this advice to be useful. We can apply this to any experience that prompts us to react emotionally about and invest our time and resources in things we can’t change. If the concern is moving forward in the best possible way, those emotions are too often the equivalent of complaining about sunk costs or crying over spilt milk. They can get in the way of good decision making.
There’s more to life than economics. But this lesson from economics, that in deciding what we should do next, the past is irrelevant because we can’t change it, applies to all human choice. Taking it seriously can help us not only make better decisions, but also recognize that however good it feels, reacting with anger or frustration to unfortunate events doesn’t affect the one thing we can change—the future. Time’s arrow runs in only one direction. Thinking carefully about costs can help us live a better and happier life.
*Steven Horwitz is the John H. Schnatter Distinguished Professor of Free Enterprise in the Department of Economics at Ball State University in Muncie, IN. He is also an Affiliated Senior Scholar at the Mercatus Center in Arlington, VA, and a Senior Fellow at the Fraser Institute of Canada. He is the author of three books, including most recently Hayek’s Modern Family: Classical Liberalism and the Evolution of Social Institutions. He has written extensively on Hayek and Austrian economics, monetary theory and history, and American economic history, and is a frequent guest on radio and cable TV programs.
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