I recently defended
the concept of opportunity cost, which most economists (both Austrians and non-Austrians) support, but which George Reisman rejects. That prompted well-argued and interesting, but nevertheless mistaken, replies from Reisman supporters Wladimir Kraus and Per-Olof Samuelsson. Instead of posting the very long reply in the comment section, I will present in a new post. Here are the edited (to reduce length of the post and focus on the relevant parts, the unedited comments can be seen here
) comments by Wladimir and Per-Olof and my responses:
Wladimir-> "I think Stefan has missed Reisman's point. For one, Reisman explicitly says (pp. 450-460) that it is better to have a bigger financial gain than a smaller one. In that sense, Reisman would agree with Marge but still reject the concept of opportunity cost as a valid construction in economics."
Me-> Again, the point here is that even though opportunity cost is not accounting cost, it is cost in a praxeological sense. It is what you forego by making a certain choice as opposed to other possible choices. It is a necessary concept to assess whether or not a choice is beneficial or not. Because all choices have opportunity costs, it is not sufficient to simply show that a choice generates benefits in order to make it a good choice.
In the Simpson’s-example, Homer could point to how he earned a dollar through his choice, so unless take the forty dollar opportunity cost into account, it must be considered a good choice.
Wladimir argued against it by saying that if you adopt a profit maximizing rule, then you would also come to the conclusion that Homer made a bad choice. This is true but misses the point. We are analyzing the actual choice of not going to work. Was that a good or bad decision? And since it meant foregoing possible income of 40 dollars, and since costs means something that you forego when undertaking a certain action, it was from a praxeological point of view clearly a cost associated with that decision.
Perhaps now some would object that the forty dollars would have been counted as an income if you had focused on the alternative action of going to work. Well, that is true, but then we're not evaluating the same action. Whether something is revenue or cost depends on what action you focus on. There's nothing really strange about that. It is similar to how a given transaction can be counted either as revenue or cost depending on whether you analyze the action of the seller or the action of the buyer.
And just as it is objectively right to characterize the money that a buyer foregoes (and could have used for other things) when he chooses to buy something as a cost, it is objectively right to characterize as a cost the money (or other benefits) that you forego by not making the alternative choice that would have given you the money as a cost.
Wladimir-> "Economists routinely use OCs to embrace not only foregone monetary benefits, such as a foregone profit from selling a good, but also purely "psychic" costs such as the foregone pleasure of not spending one's time with friends if one chooses to work, for example."
Me-> Well, yes, and rightly so
. The point is not to embrace the fallacy that working 24/7, or at least every moment you're awake, is somehow optimal. The point is to highlight to acting man that when evaluating possible actions, you choose what gives you the highest utility. Or to put it another way, whenever the amount of money you would make from working is higher than the value you perceive from doing something else instead of working, then the opportunity cost of not working is higher than the benefits of that option. This means that in a cost-benefit analysis you arrive at the conclusion that it is not a good option.
Wladimir-> "Briefly, *only* the category of productive spending, which Reisman defines as the expenditure to buy capital goods and hire labor services for the purpose of making subsequent sales, can give rise to costs of production. To see this, imagine there is no productive expenditure in the economic system. The only category of spending present is spending on consumers' goods.
What would that situation mean economically? In terms of "mere" accounting, no costs of production of account of either capital goods or labor services would be present."
Me-> Not true at all, because production of consumer's goods is associated with costs (try producing a hot dog at a hot dog stand without any cost), just as production of investment goods is. And indeed, a key cost associated with producing only consumer goods is the opportunity cost of foregone investment goods, which of course in the long term will be disastrous.
Wladimir-> "But one won't be able to recognize all that if one reasons from the point of view of opportunity cost doctrine. One will fail to recognize the pattern between low costs of production and higher profits if one reasons from the point of view of opportunity cost doctrine. One will be at a loss to understand what determines the amount and the rate of profit, how they relate to productive vs. consumptive expenditures if one reasons from the point of view of opportunity cost doctrine."
Me-> No, again not true at all. In fact the opposite is true. You need the opportunity cost concept to determine whether an investment is profitable or not. A key principle of (business) finance is that you can't evaluate a certain object simply by looking at whether or not it makes a profit in the pure accounting sense. You must also ensure that the return on invested capital is higher than the cost of capital (or discount rate), which is (should be) based on alternative uses if that investment capital. Cost of capital/discount rate is really the business management version of the economics concept of opportunity cost.
Per-Olof-> "I have a question for Stefan: If you disagree with Reisman's criticism of "opportunity cost", then what is your view on the preceding section (p. 459f) on "imputed income"? I ask this, because the criticism of those two doctrines is basically the same - namely that they both introduce incomes and costs that are fictitious."
Me-> See what I wrote about the praxeological nature of revenue/income and cost. Whether something is an income or cost depends on whether a certain action generated it or destroyed it. That means that what in accounting terms is an income could perhaps not really be an income in a praxeological sense (The Simpson example), and also what in accounting terms is an absence of cost is an income in praxeological terms. The most common example of "imputed income" is (I think), the imputed income of home owners from not renting. And that does make sense. Suppose we have two people both earning say 30,000 dollars (or euros or kronor or whatever) from their jobs, yet one earns 6,000 dollars per years from invested capital while paying 12,000 dollars in rent and another makes zero from investments yet only has 6,000 dollars in housing related expenditures from the home he own. Assuming that the 6,000 dollar difference in housing expenditure is related to the fact that the second person has invested his money in his house rather than in some securities, it should be clear that this difference in fact represents an income from the investment in the house, just as the 6,000 dollars that the renter earned from his investment in securities is an income.
Per-Olof-> "There's an expression in Swedish when someone is looking very frustrated: "You look like you have sold the butter and lost the money".
Well, if someone has sold his butter for x kronor and then - by having a hole in his pocket, or having been robbed at his way home, or whatever - having lost the money, he has of course suffered a loss of x kronor.
But suppose this person hasn't bothered to sell his butter at all, but has instead used it to butter his own bread. Isn't it true that according to the OC doctrine, he should still feel as frustrated, since he has obviously failed to earn those x kronor?"
Me-> No, of course not. The person who used the butter on his breads enjoyed a higher standard of living as he enjoyed that consumption. He enjoyed the "revenue" of the pleasure of consumption, while the other guy received nothing in return and so simply got screwed.