ECON 101 -- Opportunity Costs (a transatlantic tale of guns and butter)

In introductory economics classes, one of the first basic concepts we cover is opportunity cost. Wikipedia defines opportunity cost as "the cost of something in terms of an opportunity forgone (and the benefits that could be received from that opportunity), or the most valuable forgone alternative (or highest-valued option forgone), i.e. the second best alternative." This definition is ok as far as it goes. The challenge in the classroom is to find examples that students can easily grasp. In older U.S. textbooks, the long shadow of the Vietnam War meant that the example was typically guns and butter. Another classic student examples is "pizza and beer." To update these examples, I offer here both a European and U.S. spin on the concept, based on things the typical undergraduate has probably heard about through the European and North American news services. My modest hope is that, with examples like this, students might better understand the opportunity costs of public policy and expenditures.

A U.S. example -- The Iraq War

The New York Times and International Herald Tribune recently published estimates that place the cost to the U.S. of the War in Iraq at approximately $1.2 trillion dollars. This offers, of course, a classic chance to ask "what if..." along the lines of the old Vietnam War era examples. I have done some price checking on a list of items -- NASA's manned Mars proposal, the price of Hummers, and the total value of income by U.S. State. Based on these, we can scale the $1.2 trillion spent as follows:

We could fund the proposed NASA manned and unmanned Mars program ($120 billion), and have enough money left over for 9 International Space Stations (with full funding of operating costs -- $120 billion each).

We could permanently colonize the moon ($50 billion) and Mars ($1 trillion.).

We could buy 44 million brand new H3 hummers. This is enough for 7 out of every 10 married couples in the United States. It is also enough for every adult in California, New York, and Texas.

We could buy everything, goods and services (i.e. state GSP), produced by the U.S. plains states (Iowa, Kansas, Minnesota, Missouri, Nebraska, North Dakota, South Dakota) and the New England states (Connecticut, Maine, Massachusetts, New Hampshire, Rhode Island, Vermont) for an entire year -- and throw it away.

We could by all the U.S. manufacturing output in all 50 states (cars, trucks, laptops, jetskis, microwave ovens, 747s, again based on state GSP) manufactured in the United States for an entire year -- and throw it away.

A European example -- The Common Agricultural Policy:

A more peaceful example of costs involves the EU's Common Agricultural Policy (the CAP). The European Commission spends roughly $65 billion (€50 billion) a year on subsidies to farmers. This has, naturally, been a highly controversial subject in European politics. Over a ten year horizon, the annual costs work out to only $650 billion. This is only half the projected cost of the Iraq War. Working within this budget, Europe could have done the following instead:

Colonize the moon ($50 billion) and split the cost with the U.S. to colonize Mars ($500 billion for half).

Buy the entire output of Denmark, Ireland, and Finland for one year (goods and services).

Buy all the outstanding shares in IBM ($120 billion), Boeing ($70 billion), Daimler-Chrylser ($63 billion), and General Electric ($392 billion), based on market valuation on 19 January 2007 (according to Forbes).

Increase gross domestic expenditure on R&D by 25% a year. This assumes EU27 GDP is $13.4 trillion, the CAP costs $65 billion a year. It also uses the official Eurostat estimate that total R&D spending in Europe is 1.84% of EU27 GDP.

Public policy involves tradeoffs, and this implies that to do some things, we use resources that might have been used to do something else. This holds as much for governments and countries (and humanity) as it does for individuals and households. This is an important lesson to keep in mind.