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Monday, April 02, 2012

Why Are Opportunity Costs So Hard to See?

A new hamburger joint opened up near my house: roughly the fifth "gourmet" hamburger place within half-a-mile of me. They were right at the exact end of the upward market in high-end burgers, so that by the time they opened, the market was saturated and the place has sat basically empty since it opened: I rarely have seen more customers than employees inside. And they are on a high-rent street.

I commented to my friend that they were sure to go out of business soon, but he replied, "No, two brothers run the place, and their parents own the building, so it basically costs them nothing to stay open."

Well, it costs the brothers nothing, but it sure costs the parents a lot! Imagine a scenario where the parents had the storefront rented for $8,000 per month (what I guess the place would fetch), and the brothers tell them they want to rent another storefront, and ask to be funded $8,000 per month. The net effect on the parents wealth would be exactly the same: they lose the $8,000 of rent money every month either way. But most people would be appalled by the second situation: "How can those kids take advantage of their parents like that?" The first one, where the kids get the storefront rent-free, they accept without batting an eye.

Why do people have such a hard time recognizing opportunity costs?

5 comments:

  1. I doubt the parents have hard time recognizing opportunity costs, and for the market economy to work that's all that's really needed!

    For an enlightened populace, though - I agree. We need more than that!

    I felt the same way when we were talking to our realtor about the down payment and the size of the monthly payments, and he was saying something about how it didn't matter because it's "our money". His point was fine and probably necessary to make for some people - that you're not throwing it away, you're building equity. But it shocked me that he would even say that. I said right back to him "well it matters a lot to me whether its tied up in a house or sitting in an accessible account!"

    We're going for a big down payment, but that's because that's how the trade-off ends up working best for us - NOT because it "doesn't matter". We're quite aware of the liquidity we're giving up in order to do that!

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    1. I'm not sure about the parents: it seems to me that a lot of people would look differently at, "Let the boys have the first floor for free" and "Give the boys $8000 per month."

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  2. Why do people have such a hard time recognizing opportunity costs?

    I could explain it to you, but it wouldn't be worth my time.

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  3. I bet they like the idea of keeping an eye on their kids and knowing what they're doing. That's probably worth a lot.

    Even intermediate states (rent the store, pay the kids $5K a month, and keep a $3K profit) are worse ... do you really want to give your kid $5K per month and not know what he's doing?

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  4. They probably value "knowing where the kids are and what they're doing" a lot.

    Even intermediate states (renting for $8K, giving the kids $5K, and keeping a $3K net amount) don't have that feature. They may be even worse off. Do you really want your kid running around with a $5K allowance per month?

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