Cost and Choice: An Inquiry in Economic Theory

Epigraph

I, too, sought expression. I know now that my gods grant me no more than allusion or mention.

—Jorge Luis Borges, “Prologue” to
A Personal Anthology

Foreword

Preface

You face a choice. You must now decide whether to read this Preface, to read something else, to think silent thoughts, or perhaps to write a bit for yourself. The value that you place on the most attractive of these several alternatives is the cost that you must pay if you choose to read this Preface now. This value is and must remain wholly speculative; it represents what you now think the other opportunity might offer. Once you have chosen to read this Preface, any chance of realizing the alternative and, hence, measuring its value, has vanished forever. Only at the moment or instant of choice is cost able to modify behavior.

If you decided a few moments ago that your valuation of the alternative exceeded that expected from reading this Preface, you will have missed this economist’s pedestrian prose. But, having rejected it at the outset, you can never know what you will have missed. The benefits that you are now securing from reading the Preface are not comparable with the costs that you would have suffered on choosing the most attractive alternative. These benefits, if there are any, exist. They can be evaluated
ex post. Costs that are influential for behavior do not exist; they are never realized; they cannot be measured after the fact.

Nonetheless, when you have completed reading this Preface, there is something that will have happened, something that may be valued. You can think about what you might have done with these minutes and, if desired, you can translate these “might have beens” that never were into value terms.

An observer of your behavior, knowing the choice you face, could make an objective estimate of the minutes of resource time that reading this Preface would involve. After your decision he could look at a watch and objectively check out his estimates. If he knew your alternative earnings value, he could place some value on this resource time, a value that would be objective and that would be useful for many purposes of comparison. The observer could not, of course, accurately estimate the value that you might place on your own lost opportunities either before or after choice.

In ordinary discussion, we refer to both your own evaluations and to the observer’s as “costs.” The external observer of your behavior would say that reading this Preface will or has
cost you X minutes which he estimates to be worth Y dollars. You would normally say that the same activity “will
cost X minutes when I might sleep” or “has
cost X minutes when I might have been sleeping.” The point to be noted here is that these several uses of the word “cost” are categorically different. Linguistic usage dictates the same word for several different things. It is little wonder that we find great confusion, especially among economists, about cost.

So much for a summary of this book’s main argument. The central notions are simple, and I advance no claim to analytical sophistication. My working hypothesis is that many economists rush headlong into the intricacies of analysis while overlooking certain points of elementary economic logic. Clarification at the conceptual level may be irrelevant for particular applications, and those who are anxious to get on with solving the world’s ills may scoff at my insistence on methodological purification. Their skepticism may be increased when they recognize that, in any preliminary confrontation, their own views parallel those developed here. There are few modern economists who would dispute the elementary definition of opportunity cost. Statements that are presumably well understood abound in the standard textbooks.

I suggest that there is likely to be a significant difference between such second-chapter definitions and those which are implied in the analysis that follows. Opportunity cost tends to be defined acceptably, but the logic of the concept is not normally allowed to enter into and inform the subsequent analytical applications. My aim is to utilize the theory of opportunity cost to demonstrate basic methodological distinctions that are often overlooked and to show that a consistent usage of this theory clarifies important areas of disagreement on policy issues. In public finance alone, debates over tax incidence, tax capitalization, public-debt burden, and the role of cost-benefit analysis can be partially resolved when protagonists accept common concepts of cost. The unsatisfactory state of welfare economics can at least be understood and appreciated more adequately when the incorporated cost confusions are exposed. The once heated and long smouldering debate over the possibility of socialist calculation emerges with perhaps a different glow. Something can be said about such currently relevant topics as the draft and crime. None of these or any other possible policy applications will be discussed in exhaustive detail. Some such discussions would require a book at least as long as this to untangle the knots that cost-theory ambiguities have tied.

My secondary purpose is to trace the evolution of ideas in the conception of cost. Largely because of its relative neglect by modern economists, I emphasize the contributions that stem from a London School of Economics tradition, a tradition that has not been generally recognized and one which even its own members have taken more or less for granted.

Latter-day Austrians especially may suggest, with some justification, that the theory developed is properly labeled “Austrian.” Beyond question, an important source of the London conception is Austrian. But as I read the early Austrians along with the London contributions, I remain convinced that uniquely characteristic features were added and that the whole construction reached operational viability only in London. By way of illustrating this point, much of what seems to me to be orthodox cost theory can be traced directly to its Austrian sources. According to my readings and interpretation, Wicksteed deserves credit for providing a source of the distinctly nonorthodox LSE tradition that is equally or perhaps more important than the Austrian. American followers of H. J. Davenport, whose own ideas on cost were highly perceptive, did not generate a tradition comparable to London’s.

The basic sources of the modern London tradition are represented in papers by Robbins, Hayek, and Coase in the 1930’s. These are followed up insistently by the much neglected writings of Thirlby which extend from 1946 through 1960. Additional papers in the tradition were published by Jack Wiseman in the 1950’s. These published materials seem, however, to be only the now-visible residues of an extensive dialogue that must have been part-and-parcel of economic teaching at LSE over a span of some thirty years.

The first chapter sketches out the doctrinal history of cost theory before the 1930’s. Chapter 2 discusses the origins and development of the London theory, and Chapter 3 summarizes the theory of opportunity cost in two contrasting analytical settings. The remaining chapters in the book are devoted to applications. Chapter 4 examines cost theory in public finance, the application that aroused my own interest in the need for conceptual clarification. Chapter 5 uses opportunity-cost logic as a means of looking again at the Pigovian welfare norms. Chapter 6, the most important as well as the most difficult of the book, demonstrates the relevance of basic cost theory in the whole domain of nonmarket decision-making.

Acknowledgments

I consider myself fortunate to be able to regard Frank H. Knight as “my professor,” and his influence on my thinking is more direct in this book than in my other works. Both his insistence on getting fundamental ideas straight and his important contributions to cost theory have provided inspirations for my efforts.

More specifically, I should here acknowledge the help of many students, colleagues, and fellow scholars. Students in 1965 and 1967 graduate seminars at the University of Virginia suffered with me during the critical periods when my confusions were at their peaks. In 1967 an early draft was circulated, and I was fortunate in securing much useful revision advice. In this respect, I appreciate the help provided by William Breit, R. H. Coase, F. A. Hayek, Mark Pauly, Roger Sherman, G. F. Thirlby, Gordon Tullock, Richard E. Wagner, Thomas Willett, and Jack Wiseman. Although they probably did not realize it, both Francesco Forte and S. H. Frankel provided encouragement in discussions at critical times when my own enthusiasm wavered.

As on numerous other occasions, my work on this book was facilitated at many stages by my secretary Betty Tillman, whose loyalty and devotion are rarely matched in this increasingly impersonal world of academic scholarship.