Wednesday, February 15, 2006

Economics PhD's don't understand the opportunity cost idea

Paul Ferraro and Laura Taylor posed the following question to 200 PhD graduates in economics, 45% of which were from top-30 US economics departments:

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. 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) $0
(b) $10
(c) $40
(d) $50.

You might want to think about the answer to this before you read on. 25% of students in the sample selected option (a), 22% (b), 26% (c) and 28% (d).

The correct answer is (b) which was understood to be correct by the smallest percentage of applicants. The reason? Going to the Clapton concert means you forego $50 in benefits from the Dylan concert but save $40 that you would have had to spend to go.

This poor response is disconcerting since 'opportunity cost' is one of the most basic ideas in economics and taught in the early stages of a first-year introductory unit. That nearly 80% of PhDs cannot answer the question correctly suggests something is wrong about the way economics is taught. The suggestion: Despite an array of technical skills most economics graduates don't understand basic economics.

Do you get it right? The question is taken from R. Frank & B. Bernanke's excellent Introduction to Microeconomics. They do teach basic ideas well.

7 comments:

Bring Back EP at LP said...

Harry,

no sane man would go to a Clapton concert for free ( about what it would be worth) if Dylan was playing.
They aren't substitutes!

Anonymous said...

I hope there's a typo here and it was supposed to read "the correct answer is (b)". If not, I'm failing both economics and primary school arithmetic, since it seems clear this answer is (i) correct; and (ii) chosen by the smallest number of respondents

JCQ

hc said...

Corrected JCQ thanks.

Anonymous said...

PhDs from the University of Chicago would be more likely to get this right, not because they are brainwashed in the virtues of free markets, but because of the other Chicago tradition, which is to teach intuitive microeconomics, which means among other things knowing what opportunity cost really means.

PhDs from other top programmes, on the other hand, graduate knowing a lot about fixed point theorems, game theory and dynamic programming, but don't have the same intuitive feel for economics. (This doesn't do their career prospects any harm whatsoever.)

Anonymous said...

Still insane I see Homer! Too much Frank Ifield whilst you were young, I fear.

cs

Anonymous said...

also note that this survey was conducted during the AEA meetings when most PhD students who were there were on the job market. I was asked to fill out the survey while waiting in a hotel lobby 5 minutes before an interview. I can't remember what I answered, but you can rest assured I spent no more than 10 seconds reading the question and thinking about it. I suggest there would be a similar randomisation bias in many responses.

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