Opportunity costs? What are those?
A day before, professor Ashish Kulkarni wrote a blogpost titled ‘Can undergraduates be taught how to think like economists’ (The title is taken from a different blogpost) and although I wholeheartedly recommend you to read it in its entirety – he made three main arguments. I want to expand a bit on those because I think they’re really interesting to look into.
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Three points
First, that when students are taught economics, they are being taught the bookish principles of economics and not the real application of economics and its principles in daily life. So a student might be able to offer many definitions of say – ‘opportunity cost’ but will most likely not be able to think about opportunity costs and implement them in his daily life. (In its simplest sense, an opportunity cost is the cost you pay for doing one thing instead of other, or any other thing you could have done during that time, or using that energy). I must say that this argument is not only limited to economics, and I’m sure as Ashish already knows, is a malaise of the education system itself. The ‘thinking like X/Y/Z’ project almost always fails. I am an example myself. I have an undergraduate honors degree in physics. And even though I might be able to solve complex equations in second degrees on paper, I seldom am able to think like a physicist – which presumable would entail understanding how the pringles chip is built a certain way due to its aerodynamics, or why I can suddenly see the cold air pumped out by my AC when it is very humid etc. You get the idea. As an enterprise, the education system is very bad at making students think like the professionals of the subject they’re learning. And the reason is obvious. Thinking like an economist for example requires you to have immaculate grasp of the subject matter and the acumen to apply those concepts to complex non ideal real world systems. And no college degree prepares an economics student to become nearly half as competent to be able to do that. There is a gap of multiple orders of magnitude between having read a subject and being able to think in that subject.
Second, as an extension of the first point – undergraduates quite naturally do not understand opportunity costs. I wholeheartedly agree with this point. But three important caveats to be made here, something that Ashish also clarified in a comment. First, this claim is made for the majority of the students, not accounting for the outliers. Second, this claim is made in the background of the larger claim that on an average most people and not just undergraduates, do not understand and are not able to think in terms of opportunity cost. Third, is a mental model I developed when I thought about whether I am the majority student here or an outlier i.e. ‘If you think you understand and are able to account for the opportunity costs, you are most likely wrong’. The reason why I support Ashish’s claim is because we as a society have been made to believe that we can do everything. From inspirational messaging in popular culture, to movies, books, legends – we all have been fed the narrative that the ideal person is able to get it all. You know the creator of Pokémon was not an economist just by the tagline of the show – ‘Gotta catch em all’. The only way Ash would have been able to catch them all in a real world is if he had infinite time or resources. Because when acting under constraints a.k.a real life, you need to think in trade-offs. Just pick up any real life legends in any field and you will instantly see the trade-offs that they had to make. Michael Jordan traded off a stable life and many personal relationships for greatness. Many founders trade off security, stability and conventional success for the chance to create something new. Nobody can do it all. Everything is a trade off.
Opportunity costs are built on the notion of trade off i.e. the cost of doing activity X is losing out on Y. If I chose to do X, I am making a trade-off between X and Y in which I choose X. The average intelligent individual does not think like that. The average intelligent human thinks as if they have infinite resources or time. They think linearly i.e. I’ll first do X and then do Y, when as a matter of fact most things that you do are not choices you take in vacuum, but have consequences for the kind, scale, quality and nature of things you can do afterwards. So if this is the situation of the average intelligent human, the expectations from an undergraduate are even lower precisely because they are an undergraduate, and have not had (most likely) the experience and the insight to be able to account for opportunity costs.
There is a wonderful thread by Nishant Jain on twitter explaining how when he and his father went to FIITJEE to explore the option of studying for IIT, they were told that Nishant will have to sacrifice his hobbies, sports and everything else because there is so much homework and modules to do. Alarmingly his father understood that he cannot let his son trade off all that time that he would end up spending while preparing for that exam and did not enroll him into the course. Nishant writes that he was the only student in his batch that did not do so, but he also had the one thing that nobody else had – free time to pursue his hobbies. He wrote blogs, played sports, read books etc. It is important to note that Nishant’s father implicitly understood the concept of opportunity cost. The opportunity cost of preparing for the IIT JEE was too high. It was too high because there were so many amazing things that Nishant could have done, which he did, which would have maximised his soul more than clearing any competitive exam could.
Third, that most people realize and understand the concept and impact of opportunity cost by real life experience. Here is the thought experiment he came up with to prove this claim:
Let’s say there’s two teams in some corporate environment somewhere. And for whatever reason, these teams don’t get along well together. Both sides believe that they’re in the right, and the other side is in the wrong, and we’ve reached Mark Twain territory.
Are they going to go to their manager(s) and ask them to resolve this issue? Sure, it may seem like a good idea initially. But said managers, I can assure you, have things to do. Deliverables to, well, deliver. Teams to manage. Projects to initiate. Other people to manage. And so the manager(s) might listen to both teams long list of complaints once, perhaps twice.
But eventually the price mechanism will come to the party. The more the two teams spend time on this, rather than on work, the more expensive the situation becomes for the enterprise. Because a commodity that is limited (time) is being spent on non-productive work (productive, in this case, can be thought of as remunerative).
Since the whole point of the firm’s existence is to maximize revenue, this will not be tolerated for too long. The manager(s) will eventually say one of the following:
Figure it out yourselves, but get the work done, for that’s what matters. Or else.
Let’s reallocate, forcibly, both teams on to other projects. This will usually be accompanied with a mental note to themselves that truly important projects in the future should not be given to these team members. For obvious reasons.
Or let’s shut down the project, because the point of a firm is to do the work that earns one the money. Start something new, with a new set of people.
Now, since the team members are old enough to know that eventually pts 1 to 3 will occur, they usually swallow their differences and get the work done. Sure, bitching about the other team will happen in bars and pubs in the evening, and sure the other team won’t be called home for dinner anytime soon. But in the workplace, professionalism will win out, due to the price mechanism. In more explicit terms, they will get the work done because they know that otherwise they will be fired.
Ashish’s core argument is that the reason why adults start to understand opportunity cost is precisely because there are more visible consequences to their actions. What this means is that the hypothetical employee, as Ashish wrote, knows that if he does not do his work, he will most likely be fired. And because that is a visceral enough outcome, he realizes that the cost is not justified. I would perhaps disagree a bit with Ashish here in the framing of this argument. I would claim that what this hypothetical employee has learnt is the idea of cost and benefit and not opportunity cost. He realized that the cost of pushing his agenda is too big and the benefit too low. More so when he framed the cost in terms of not being able to provide for his family. I don’t think he has come to appreciate the larger idea of opportunity costs by itself that he can now implement in other life situations. So actually, the situation probably is bleaker than we started with. That most probably even experience does not teach the concept of opportunity cost. Which, I understand is a quite tricky conclusion to come to. We are thus left with the question of how can we start thinking like an economist? At least in terms of understanding the opportunity cost of doing things. I am wholly ill equipped to even think about this question. And would really like if Ashish wrote a post on it. But if were to take a guess, it would probably require deliberate practice to make it into a force of habit. I do not think merely understanding the concept is enough in order to also be great at implementing it. Probably why the intersection of great engineering teachers and great engineers is very slim.
I am actually more interested in the other major claim that Ashish made, that we also talked a little bit about in our podcast conversation, that students do not realize the opportunity cost of engaging in zero sum politics during their time in undergraduate. Here is an extract:
Adults don’t necessarily grasp the argument that the opportunity cost of politics is work. But they understand the rules of the game called life. They do understand that the opportunity cost of politics is an increase in the probability of losing their wages. And so they still practice politics, but more covertly. Not, in other words, an ideal situation if the system is trying to optimize work, but hey, better than overt politics.
How to get students to understand that the opportunity cost of politics is learning? That the opportunity cost of politics is not getting fun projects done? That the opportunity cost of resolving arguments, or adjudicating who said what to whom and when is not being able to start other fun learning based projects? There’s no price mechanism at play, there’s illusions of immortality (they don’t get that time is limited), they don’t have the responsibility of putting food on the table (they come from a socialized economy called a family), and they haven’t experienced the tragedies of adult life.
To them, winning a political argument against the other side is the best use of their time.
He specifically notes that the reason why undergraduate students are not likely to understand and think in terms of opportunity costs to their actions because most of their actions and decisions do not have immediate large impact on their family or themselves. So prioritizing spending multiple hours online to argue for your political agenda over say - your studies will not have as big an impact on either the student or their family. Maybe other than a drop in their grades, which again, is not linearly caused. Does it mean that students should not do politics? What does that imply? Would that encourage a politically apathetic population? Or is there something more nuanced about understanding the zero sum nature of whiling away your time in political debates online and offline bolstered by a lack of understanding of opportunity cost? I will follow on this question in a subsequent post.