What is Cost?

When we think about “cost,” we often think about prices, such as comparing the prices of cars. But the proper way to think about costs is not simply to consider the money we're spending on a certain item, but all of the other possibilities we're giving up in order to obtain that item.

Henry Hazlitt was an American journalist who wrote the book Economics in One Lesson. In it, he starts with a story about a baker who owns a shop.

Imagine now that a kid decides to throw a ball through the front window of a bakery. The baker is understandably upset but is comforted by a friend who encourages him to see the larger picture. The baker now has to buy a new window, and this purchase will benefit the glass store. The glass store now has to buy materials and can pay its workers. Perhaps some of these workers end up buying the baker’s bread. So this act of destruction isn’t really a tragedy, but an event that will benefit the local economy and others!

Unfortunately, this clever scene doesn’t really tell the whole story.

After all, if the baker’s store window had not been broken, he would have both his window and his money, money which he could have spent in other ways than making repairs.

Perhaps he would have bought a new sign for his business or a new suit for himself. The gain for the glassmaker is a loss for the signmaker or the tailor. Unfortunately, now we will never see how the baker would have spent his money. Instead, we will only see the new window that he had to fix.

What Hazlitt described is called opportunity cost. The money spent on the new window is not simply the dollar price of his purchase, but of all the goods and services he could have purchased with that money.

In the words of Hazlitt: “The bad economist sees only what immediately strikes the eye; the good economist also looks beyond.”

If the mistake in the baker’s friend’s argument is obvious to you, you may be surprised to learn how many “bad economists” there are in the world today.

For example, Paul Krugman, a well-known economist who writes for the New York Times, has argued that incidents such as 9/11, national disasters, or even a fictional alien attack would stimulate the American economy, just like the baker’s broken window!

Although it’s certainly true that these tragedies create jobs in construction, cleanup, or anti-alien weaponry, that doesn’t mean society is actually better off. Just like with the broken window, the companies that benefit from these projects do so at the expense of others.

Remember, the purpose of the economy is not simply to work or make money—it is to satisfy our needs and wants as individuals. If no one actually wants or needs an anti-alien weapon, then the money, time, and resources spent on them are wasted, when they could have been used for producing things that people actually want or need.

The opportunity cost is everything else that could have been done with the time, the resources, and the money that are no longer available.

This is why we must look at the larger consequences of our actions—be it with how we spend our money or our time. When we think about this, it means that there will be more resources to make things we actually want, making each of us richer and happier.

Unfortunately, the government, like the baker’s friend, usually has a really hard time thinking like a good economist.

Governments are not producers, or manufacturers, or bakers who offer goods or services in exchange for money. only get their money from taxes, and then use that tax money on projects of their own choosing.

For example, if a government taxes the community to pay for a new football stadium, it is easy for a politician to point to a big game and say “This is what your taxes paid for!” But what no one can see is all the things the public lost because of the taxes the government placed on them.

If not for the taxes, the people would have that money to spend or save as they choose. As individuals, we may want to buy a new pair of shoes, go on a vacation, start a new business, or save for the future—the possibilities are endless. At the end of the day, we know what we need better than any government official does.

This is why it is important for everyone to think like good economists. Doing so allows us to make better decisions—in the long term—about how we spend our money. And it empowers us to hold politicians accountable when they try to take it from us.

Questions:

Do you ever regret buying something after you have purchased it?

Have you ever wondered how politicians can make big campaign promises, without thinking about who pays for it?

Do you have a job? If so, have you ever looked at how much money is taken out of your paycheck because of taxes? What would you do if you could spend that money the way you would like?

Articles:

"One Lesson"
"Why It's Important to Understand "Economic Costs"

Free Books:

That Which is Seen and That Which is Unseen
Economics in One Lesson by Henry Hazlitt