Do Economists Recognize an Opportunity Cost When They See One

Do Economists Recognize an
Opportunity Cost When They See
One? A Dismal Performance from the
Dismal Science
PAUL J. FERRARO∗
Laura O. Taylor†
An Article Submitted to
The B.E. Journals in Economic
Analysis & Policy
Manuscript 1469
∗
†
Georgia State University, [email protected]
Georgia State University, [email protected]
Copyright c 2005 by the authors. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic,
mechanical, photocopying, recording, or otherwise, without the prior written permission of the
publisher, bepress, which has been given certain exclusive rights by the author.
Do Economists Recognize an Opportunity
Cost When They See One? A Dismal
Performance from the Dismal Science∗
PAUL J. FERRARO and Laura O. Taylor
Abstract
One expects people with graduate training in economics to have a deeper understanding of
economic processes and reasoning than people without such training. However, as others have
noted over the past 25 years, modern graduate education may emphasize mathematics and technique to the detriment of economic reasoning. One of the most important contributions economics
has to offer as a discipline is the understanding of opportunity cost and how to apply this concept
to all forms of decision making. We examine how PhD economists answer an introductory economics textbook question that requires identifying the relevant opportunity cost of an action. The
results are not consistent with our expectation that graduate training leads to a deeper understanding of the concept. We explore the implications of our results for the relevance of economists in
policy, research, and teaching.
KEYWORDS: opportunity cost, role of economics
∗
Authors may be contacted at PO Box 3992, Department of Economics, Andrew Young School
of Policy Studies, Georgia State University, Atlanta, Georgia, 30302-3992. Additional contact
information is: [email protected] and [email protected] The authors would like to thank Peter
Bluestone, Douglas Campbell, and Robynn Cox for research assistance, as well as David Colander,
Robert Frank, Don Fullerton, Anne Krueger and three anonymous referees for helpful comments.
FERRARO and Taylor: A Dismal Performance from the Dismal Science
1
INTRODUCTION
“Equipped with thousand-plus page encyclopedic texts, many
instructors feel they must acquaint students with every
economic idea that has ever been written about. The
unfortunate result is that, when the dust settles, most students
leave these courses never having fully grasped the essence of
the subject. For example, the opportunity cost concept, so
central to our understanding of what it means to think like an
economist, is but one among hundreds of concepts that go by
in a blur. Opportunity cost is more important than, say, the
idea that the short-run average cost curve is tangent to the
long-run average cost curve at the output level for which
capacity is at the optimal level. But one would never realize
that from the relative emphasis these topics receive in many
first-year courses.” -- Robert H. Frank’s Introductory
Microeconomics syllabus (1999, Cornell University)
In an influential paper, Colander and Klamer (1987) surveyed students at
seven top-ranking graduate programs in Economics. Based on the responses, they
argued that graduate programs emphasized mathematics to the detriment of
empirical content and economic reasoning. The report from the Commission on
Graduate Education in Economics (COGEE), developed by a dozen eminent
economists, echoed this sentiment (Hansen, 1991; Krueger et al., 1991) and
included an oft-quoted concern that graduate programs generated “too many idiots
savants, skilled in technique but innocent of real economic issues” (Krueger et al.,
1044-1045).
In an update to his earlier study, Colander (2005) finds that students in the
same graduate programs place a somewhat smaller emphasis on mathematic skills
and much more on empirical applications, but building skills in economic
reasoning continues to receive relatively less attention. We examine Colander’s
conjecture that strong skills in economic reasoning are still lacking in the
profession by asking PhD economists and PhD students attending the 2005 ASSA
meetings a very simple question that tests their understanding of opportunity
costs. The concept of “opportunity cost” is arguably the most fundamental
concept in economic reasoning and thus an appropriate starting point for
considering Colander’s conjecture. While we acknowledge that the responses of
economists to a single question is a narrow context from which to make
inferences about the entire discipline, we believe that the answers to our question
offer substantial insight into the training of economists.
2
SURVEY DESIGN
Four graduate students administered the survey to voluntary participants at the
2005 Allied Social Sciences Association (ASSA) meetings in Philadelphia.
Students intercepted potential survey respondents in the general meeting space of
the primary hotels in which ASSA functions were taking place. The survey
consisted of one question related to opportunity cost, and three follow-up
questions asking the respondents whether or not they are a student, the year in
which their PhD was awarded if they are not a student, their major field of study,
and whether or not they have taught an introductory economics course.
Table 1. Characteristics of Respondents.
Respondent Characteristicsa
Number of Students
Year PhD was Awarded (if not a student)
Degree is from a top-30 institution
Respondent has taught introductory
economics
64/192
1991b
[1962 – 2004]
83/185
120/197
a
Respondent characteristics are reported as: {the number for which the characteristic is
present}/{total number of responses to the question}.
b
Mean year [range] in which the PhD was awarded.
Approximately 200 participants in the ASSA conference completed our
survey, and they represented graduates of over 70 different institutions.1 As Table
1 indicates, approximately 45 percent of our respondents were from institutions
currently ranked in top-30 economics departments (Coupé, 2003).2
Approximately one-third of the sample were students. Among respondents who
have already received their degrees, the mean year of graduation is 1991 (median
= 1995). There are respondents who received their degrees as early as the 1960’s
and as recently as 2004. In addition, approximately 61% of our sample (including
both students and PhD holders) have taught an introductory economics course at
the university level.
1
Four others refused to answer the survey after seeing the opportunity cost question or observing
that we were requesting degree-awarding institution information.
2
We use two alternative sources for economics department rankings: Dusansky and Vernon
(1998) and Coupé’s update of his article for the period 1993-2003, available on his website
(www.econphd.net/rank/rallec.htm). All results are unaffected by which source we use to define
the top-30 departments.
FERRARO and Taylor: A Dismal Performance from the Dismal Science
3
The opportunity cost question we presented to respondents was adapted
from page 4 of Robert Frank and Ben Bernanke’s textbook, Introduction to
Microeconomics (2001), and was presented exactly as follows to ASSA survey
respondents:3
Please Circle the Best Answer to the Following Question:
You won a free ticket to see an Eric Clapton concert (which
has no resale value). Bob Dylan is performing on the same night
and is your next-best alternative activity. Tickets to see Dylan cost
$40. On any given day, you would be willing to pay up to $50 to
see Dylan. Assume there are no other costs of seeing either
performer. Based on this information, what is the opportunity cost
of seeing Eric Clapton?
A.
B.
C.
D.
$0
$10
$40
$50
SURVEY RESULTS
We were surprised by the diversity of opinion regarding the value to which the
term “opportunity cost” applies. As Table 2 indicates, the most popular answer
was $50, with 27.6% of respondents choosing this answer. The second most
popular answer was $40, with 25.6% of respondents choosing this answer. The
third most popular answer was $0, with 25.1% of respondents choosing this
answer. The correct answer, $10, was the least popular, with only 21.6% of
respondents choosing this answer. In essence, the answers given to us by welltrained economists appear to be randomly distributed across possible answers.
Given the correct answer was the least popular, we believe it worthwhile to
state why $10 is the opportunity cost of seeing Eric Clapton. When you go to the
Clapton concert, you forgo the $50 of benefits you would have received from
going to the Dylan concert. You also forgo the $40 of costs that you would have
incurred by going to the Dylan concert. An avoided benefit is a cost, and an
avoided cost is a benefit. Thus, the opportunity cost of seeing Clapton, the value
you forgo by not going to the Dylan concert, is $10 – i.e., the net benefit forgone.
3
We simplified the question by paring the text and rendering the format multiple-choice rather
than open-ended. We also made the question more precise by writing that there are no other costs
involved other than those stated in the question.
4
Table 2. Opportunity Cost Survey Results.
Answer is “A. $0”
Answer is “B. $10”
Answer is “C. $40”
Answer is “D. $50”
Number of
Observations
199
199
199
199
Number Choosing Answer
(Percent)
50 (25.1%)
43 (21.6%)
51 (25.6%)
55 (27.6%)
Based on our conversations with faculty and students who answered the
question, we believe that respondents who answered $50 erroneously believed
that only the willingness to pay to see Dylan was relevant. Respondents who
answered $40 seemed to conflate the cost of the ticket to see Dylan with the
opportunity cost. We are less certain about why many respondents chose to
answer $0, but our conversations indicate that many decided there must be no
opportunity cost if the Clapton concert was free.
We also examine whether there are differences in responses across
respondent characteristics. As Table 3 indicates, Chi-square and Fisher-exact
tests reveal no significant differences in the percentage of correct answers when
we compare: students and those who have graduated; graduates from top-30
institutions and graduates from all other schools; or respondents who have taught
a principles course and those who have not. To speak directly to the impact of the
Krueger et al. (1991) report, we divide our respondents into two cohorts based on
the year in which they received their Ph.D. We assume that the earliest we might
see changes in graduate programs as a result of the Krueger et al. report would be
the year after the report was published. Students who matriculated in 1992 would
graduate in 1996 or later. Thus, we divide our respondents into two groups: those
who graduated prior to 1996 and those who graduated in 1996 or later (or who are
currently students). As Table 2 indicates, there is no significant difference in the
percentage that chose the correct answer between these two groups. These results
are not sensitive to our choice of graduation year to define the cohorts. There are
no significant differences between the two cohorts no matter which year we
choose as the ‘cut-off” date (we considered all years between 1991 and 2003).
The only significant difference we see across groups of respondents is by
major field of study/research. We broadly categorize respondents into five areas:
business economics, applied microeconomics, micro-theory, macroeconomics/
international economics, and methods. Although not reported in Table 2 for
succinctness, pair-wise comparisons of the number of correct responses by field
indicate a significant difference between macro/international and applied
microeconomics and between macro/international and micro theory, although the
difference with applied microeconomics is only significant in a Fisher-exact, one-
FERRARO and Taylor: A Dismal Performance from the Dismal Science
Table 3. Opportunity Cost Survey Results by Major Cohort.
Number of
Number Who Chose
Observationsa $10 (Percent Correct)
Results by Degree Status
Ph.D. Candidate
64
12
(20.3%)
Degree Already
128
30
Awarded
(23.4%)
Results by Rank of Alma Mater
Top-30 Institution
83
19
(22.9%)
Institution Ranked
102
23
Lower than 30
(22.5%)
Results by Instructional Status
Have Taught
120
27
Principles
(22.5%)
Have Not Taught
77
15
Principles
(19.5%)
Results by Year of Degree
Student or Graduate
127
29
Post-1995
(22.8%)
Graduate 1995 or
63
14
Earlier
(22.2%)
Results by Field of Specialization
Business Economics
26
4
(15.4%)
Applied Micro
95
24
(25.3%)
Micro Theory
7
3
(42.9%)
Macro/International
49
7
(14.3%)
Methods
17
4
(23.5%)
a
5
Pearson χ2
(P-value)
0.2397
(0.624)
0.0031
(0.956)
0.2549
(0.614)
0.0090
(0.924)
See text
for
discussion.
The number of observations in a paired group may not sum to 199 because of item nonresponses.
b
Examples of fields reported by respondent by our categories are:
Business: “accounting”, “finance,” and “organizational design”
Applied microeconomics: “labor,” “health,” “public finance,” and “economics of education”
Micro theory: “game theory”
Macro/international: “monetary,” “international trade,” and “economic growth”
Methods: “econometrics,” “experimental economics,” and “statistics”
6
sided test. Macro/international is not significantly different from business
economics or methods at any conventional level of significance. Given the small
numbers in some cohorts and the potential to define fields in other ways, these
differences across fields are intriguing but only suggestive.4
DISCUSSION OF RESULTS
Given our surprise, and that of our colleagues, regarding the diversity of
responses, we consider several alternative explanations for our results. One might
argue that our results could arise if respondents invested insufficient cognitive
effort to answer the question. We find this explanation unlikely. First, the
question is straightforward and should not require great cognitive effort by PhDlevel economists. When budgeting the time endowment for an undergraduate
exam, most professors would likely allot no more than one minute to an
opportunity cost question. Moreover, respondents spent, on average, close to five
minutes answering the survey, which consisted only of the opportunity cost
question, and four follow-up questions about the year their PhD was awarded, the
institution they attended, their sub-discipline, and whether or not they have taught
a principles course. Our interviewers reported that most respondents were clearly
thinking about their answers; few respondents made their marks quickly and
returned the survey. Some respondents orally noted the questions with regard to
institutional affiliation and sub-discipline, and seemed to take their response
seriously as a reflection on their alma maters and field of study. Finally, we note
that we pre-tested our question with two-dozen colleagues at different institutions
(of whom only 21% answered the question correctly) and spoke with most of
them after they answered the question. Not a single respondent stated that he or
she answered the question incorrectly because of random guessing (which would
have been the most ego-protecting explanation to give). Instead, all were
applying a flawed concept of opportunity cost to the question (e.g., a couple
believed one needed to know the willingness to pay for the Clapton ticket to
answer the question).
Another potential criticism of the survey might be the wording of the
question or the way in which we administered the survey. Potential factors that
might have influenced our results are the choice of performers (who might not be
familiar to everyone), the simplicity of the question itself (i.e., the question was so
4
Parametric models also support these findings. Probit models were estimated relating whether
or not a respondent answered correctly to each of the factors reported in Table 3. Models were
estimated that included the year of degree as a categorical variable, as well as a continuous
variable (coded as years since the award of the degree). The models indicate that the only factor
that is a significant predictor of whether or not the respondent answered the question correctly is
the variable indicating that the respondent’s field of study is micro theory (the variable indicating
macroeconomics is the respondent’s field of study was the variable left out of the model).
FERRARO and Taylor: A Dismal Performance from the Dismal Science
7
simple that many respondents thought it might have a trick answer), or from the
pressure associated with having to answer the question knowing that the
respondent’s basic grasp of economic reasoning would be judged by a graduate
student interviewer (i.e., too much cognitive effort, which could lead to errors).
We find these potential explanations curious. The respondents were, after all,
among the most well-trained economists on the planet, who make their living by
answering questions and engaging in debate with students or with equally welltrained colleagues. Problems are often framed in terms of ith and jth players, or
with notoriously contrived terms such as the “widget.”
In conversations with colleagues who did not choose $10, some have
suggested that the correct answer “depended on what one meant by value.” In
particular, a common response has been to propose that those choosing $50 were
focused on the “gross” opportunity cost as opposed to the “net” opportunity cost
of seeing the Clapton concert.5 Even if we were to agree that such a distinction is
valid in economic theory (we have never heard or read of the need to be precise
about the “type” of opportunity cost to which one is referring), the failure to
differentiate gross versus net opportunity cost in the question cannot explain the
choices over more than half of the respondents who chose $40 or $0.
Nonetheless, as a colleague pointed out, “[n]othing is important about a
definition. It is only useful insofar as it helps us to think about a problem and to
make the right decisions.” In these regards, we rephrased the question and
conducted a second survey. The revised question reads as follows:
Please Circle the Best Answer to the Following Question:
You won a free ticket to see an Eric Clapton concert (which has
no resale value). Bob Dylan is performing on the same night and is
your next-best alternative activity. Tickets to see Dylan cost $40. On
any given day, you would be willing to pay up to $50 to see Dylan.
Assume there are no other costs of seeing either performer. Based on
this information, what is the minimum amount (in dollars) you would
have to value seeing Eric Clapton for you to choose his concert?
A.
B.
C.
D.
5
$0
$10
$40
$50
An anonymous referee has suggested that perhaps the reason some respondents chose $50 as the
answer was that they considered the $40 cost of the Dylan ticket a sunk cost (even though the
question does not indicate that the ticket had already been purchased). Again, even if some
respondents considered the $40 ticket price a sunk cost, we are left with over 50% of the sample
clearly answering the question incorrectly.
8
We changed only the last sentence in the question. The reformulated
question is designed to test whether or not economists can identify the relevant
tradeoffs that guide decision making under the neo-classical economic paradigm.
We posed the question to 34 individuals, of which only 15 answered this
rephrased question correctly. A little over half of these individuals were ASSA
participants and the remaining respondents were from economics departments at
three Ph.D. granting universities in Georgia. The percent that answered the
rephrased question correctly (44 percent) is significantly higher than the
percentage that answered the original question correctly (χ2 = 7.87, p-value =
0.005), but still less than 50%.6
In our opinion, the most likely explanation for our results is best summed-up
by a question posed to us by a colleague who is a faculty member at a Class I
research university, who graduated from a top-20 institution, and has taught
microeconomic theory at the PhD-level. This respondent answered the original
version of the question incorrectly in a pre-test. As we did with many of our twodozen pre-test respondents, we allowed him to choose again after revealing to him
that his answer was incorrect. After three incorrect choices ($10 was only arrived
at by elimination – a common finding in our pre-tests of the survey), our
colleague posed the following question: “When would I have learned the concept
of opportunity cost? I don’t remember hearing that word used in graduate
school.”
Indeed, the concept of “opportunity cost” is usually covered in the first week
of an introductory undergraduate class and often deemed so straightforward as to
not require further teaching time. We reviewed the indexes of three commonly
used graduate economics textbooks and the term “opportunity cost” was not
listed. 7 A scan of each page in these books also failed to reveal the phrase, but
we recognize that it is nearly impossible to scan a textbook by eye without error.
We believe that graduates of PhD programs have not mastered the concept of
opportunity cost precisely because they have rarely been exposed to situations in
which a deep understanding of the concept was required for advancement (see
below).
IMPLICATIONS
One may wonder, “So what if PhD economists cannot identify an opportunity cost
in a simple contrived question?” We believe that the failure of nearly 80% of our
6
There was little difference in the percentage of correct responses in the ASSA group and the
Georgia group: 47% vs. 40%.
7
The texts were Jehle and Reny (2001), MasCollel, Whinston and Green (1995) and Varian
(1992).
FERRARO and Taylor: A Dismal Performance from the Dismal Science
9
sample to answer the question correctly has important implications for teaching
and, to a lesser extent, economic research.
The inability of most PhD economists to answer a simple opportunity cost
question implies that students at colleges and universities are unlikely to learn this
crucial concept in a way that allows them to apply it in their daily lives. Recall
that over half of our ASSA sample had taught a principles course in the past, but
only 22.5% of these teachers answered the question correctly. The teaching of
introductory economics has long been a target of criticism in the economics
profession (see, for example, Hansen et al., 2002). As far back as 1963, George
Stigler wrote (p.657),
“[T]he watered down encyclopedia which constitutes the present
course in beginning college economics does not teach the student
how to think on economic questions. The brief exposure to each of a
vast array of techniques and problems leaves with the student no
basic economic logic with which to analyze the economic questions
he will face as a citizen.”
The connection between the teaching of principles courses and students’
understanding of opportunity costs is emphasized by the results of an additional
survey we conducted. We administered the original opportunity cost question to
358 undergraduate students in the first week of an Introduction to
Microeconomics course, before any lecture on opportunity costs was given. We
asked students to indicate whether they had taken an economics course in the past.
Of these students, 270 (76%) had taken Introduction to Macroeconomics or a
high-school economics course and 86 (24%) had never taken an economics course
before. Of the students who had taken a previous economics course, only 7.4% of
them answered the opportunity cost question correctly. Of the students who had
never taken an economics course before, 17.2% answered the question correctly.
The difference between the two groups is significantly different (Pearson χ2 =
7.13, p-value = 0.008). Interestingly, there is no significant difference between
the proportion of PhD economists that answered the question correctly (21.6%)
and the proportion of undergraduates with no prior exposure to economics that
answered the question correctly (Pearson χ2 = 0.714, p-value = 0.398). The data
thus suggest that advanced study is necessary to rectify the damage done to
economic intuition by an introductory economics course.
The obvious extension to the above inquiry is to examine the principles of
economics textbooks upon which lectures are based, and which are likely to be
the only economics reference book most individuals will ever read. We examined
nine top-selling, college-level introductory economic textbooks to determine the
way in which opportunity cost was defined and the way in which practice
10
questions were posed.8 After reading the introduction to opportunity cost, and all
discussions that include the term opportunity cost, including dialogue boxes and
examples (we reviewed any page listed in the index under “opportunity cost”), we
believe that seven out of nine do not provide the reader with enough information
to answer our opportunity cost question correctly. Six of the nine textbooks use
phrases such as “the value of the next-best alternative” or “the benefit of the nextbest alternative” to define opportunity cost.9 Three of the nine do not refer to
“value” but instead refer to “what you give up” when undertaking an activity – the
“what” is left undefined.
While the definitions given in the texts we reviewed are correct, they are
terse and rely on examples to help the reader gain a deeper understanding of the
term and what is meant by “value” or “benefit” of the next-best alternative.
However, most texts use one-dimensional examples – examples that only imply
foregone benefits of an alternative activity. For example, to describe opportunity
cost, six of the nine books discuss the reader’s opportunity cost of attending
college or taking a college course, or a hypothetical example of a college athlete
who could be playing professional sports and earning a large salary rather than
attending college. In all but one of these six textbooks, the opportunity cost is
simply the foregone benefit of the next-best alternative (e.g., foregone wages). In
only two of the nine reviewed textbooks were the opportunity cost examples rich
enough for the reader to realize that one must consider both benefits and costs of
the alternative activities. Based on these textbook examples, it is not surprising
that fewer than 1 in 10 students with exposure to introductory economics could
determine the opportunity cost of attending the Clapton concert in our question.10
We now turn to a much more difficult question: “Does it matter for
economic research if economists cannot identify the opportunity cost in a simple
contrived question?” We do not have a clear answer to this question. Obviously,
it matters for PhD economists who take jobs in the private or government sectors
in which opportunity costs are the fodder of daily decisions (and the only input
economists are likely to have). For academic research, it apparently does not
8
The textbooks we reviewed were: Arnold (2005), Case and Fair (1999), Colander (2004), Frank
and Bernanke (2001), Mankiw (2004), McEachern (2006), Miller (2001), Parkin (2005), and
McConnell and Brue (2004).
9
The definitions are all quite similar and very close to what we have written, just arranged slightly
differently from a grammatical standpoint. For example, Miller (2001) writes “The value of the
next-best alternative is called opportunity cost” and Parkin (2005) writes “The highest value
alternative that we give up to get something is the opportunity cost.”
10
The situation in high-school economics courses is likely as bad or worse. Note that in 23 states,
high-school economics teachers are not required to have had any college-level economics courses
and thus probably learn their economics from the textbook alone. In the 27 states with minimum
course requirements, the average requirement is a single college-level economics course (Aske
2003).
FERRARO and Taylor: A Dismal Performance from the Dismal Science
11
matter. Theoretical research rarely requires that an individual calculate an
opportunity cost in the form of a word problem. Empirical research tends to focus
more on appropriate techniques to make inferences about parameter values in
models. But can economists be relevant in the world of ideas and policy if we
cannot answer simple, albeit contrived, opportunity cost questions?
CONCLUSION
In their introductory textbook, Case and Fair (2001) write that, “[a] good way to
introduce economics is to review three of its most fundamental concepts:
opportunity cost, marginalism, and efficient markets. If your study of economics
is successful, you will use these concepts every day in making decisions.” We
chose one of these fundamental concepts, opportunity cost, and set out to
determine if PhD economists and students in undergraduate economics courses
had acquired a solid understanding of the concept. Our results indicate that few
respondents have the ability to apply the concept to a simple example.
We believe the implications of our results for undergraduate teaching are
important. If we are not able to instill in our students a deep and intuitive
understanding of one of the most fundamental ideas that the discipline has to offer
(and the idea whose frequent application could do the most good in peoples’
private and public lives), then we wonder what we can claim as our value-added
to the college curriculum.
Moreover, the incomplete understanding of opportunity costs acquired in the
undergraduate curriculum persists through graduate education because the
concept is neither revisited nor applied in most graduate curricula. In 1991,
Krueger et al. (p. 1052) reported that they believed “graduate education can be
improved if relatively more emphasis is given to providing students with
applications of the tools of economics to economic problems.” Our results
suggest there is still ample room for improving the ability of graduate students to
apply economic reasoning to real-world problems.
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