Greetings, today I want to continue our discussion about scarcity. Scarcity means that we just don't have enough to go around. And part of the things that scarcity gets tied to is a very key concept in economics, perhaps one of the most key concepts that you can take away from this course. And that's this fundamental concept of opportunity cost. Now the formal definition of opportunity cost is the value of the next best foregone alternative. So what is opportunity cost? Well, right now, you're watching this video. Now, you could be doing something else, and in your mind, there's probably something else you really would like to do. Maybe it's binge-watching Friends on Netflix, or maybe it's a down at the corner coffee shop with an nice latte and a newspaper. There are all sorts of alternatives you can think of, but you're here. But every time you do something, you're definitionally not doing something else. In economics, that's very powerful. So I got this little prop here, it's a $5 bill, it's a real $5 bill. What good is this $5 bill? Well, you can't eat it. I suppose you could use it to wallpaper your house, but the fundamental thing about this $5 bill is every single one of you, every single person watching this video has inside their head the embodied notion of the value of this $5 bill. The $5 bills are no good to for you for food. But you know you can transfer this for something that is very, very, very valuable to you. And every time you transfer one of these $5 bills, you don't have it to get something else. So if you take the $5 bill and take it to the coffee shop and get a cup of a latte and a newspaper, you've blown the entire $5 bill. You don't have that to take instead for lunch. Or you don't have that maybe for an Uber ride back to your house. Every time you use one of these $5 bills for something, you're giving up something else, and that's a powerful concept. There's a very famous economist named Milton Friedman, and Milton Friedman is one of, I mean, he was a Nobel Prize winner. He's no longer with us. But Milton Friedman is famous for the phrase, there's no such thing as a free lunch. The idea is that even if I were to tell you, hey look, come on, I'm going to take you to lunch and I'm paying. That's not a free lunch because you have to put up with me. You could have been doing something else. Okay, you could have been with your friends or something. But you decide, I better not make the professor upset, so I'll go along with it. There's always these opportunity costs of something else. I'm going to tell you true story. When I was getting my PhD at Cornell, I made great friends with a guy who was in the law program. He's very good. He actually graduated number two in the law school. But when I met him, he was a first-year law student, and we chummed around a lot because we both liked baseball, and it was something to talk about. Now, he was if you've ever been to Ithaca, New York, where Cornell is, it's very steep. The hills just go straight up and straight down, and you can't hardly ride a bicycle there because you have to walk it up and you have to just ride on your brakes down. So my friend, he really wanted to get a car, but he said, I can't afford it. And what really made him mad was his brother, who was an undergrad, had a car. Now remember back in those days, we're talking about 1975, new cars were like $3,000, okay. So it wouldn't take a lot of money, and he didn't even need a new car. And I said, he was really jealous of his brother who had the car. And I said, well just go buy one. And he goes, I can't, I don't have any money. And I said well, what'd your brother do? He goes we had a paper route. He saved his money and I spent mine on baseball cards and going to games and things like that. And I said, well just take a loan, and he goes, then I have to pay interest on that and I said, yeah. Well your brother's paying interest on it too. And he said, what, did you not hear me Larry? He took money out of his own bank account and bought that car, and I said, yeah, well that's an opportunity cost, right? If he had left it in his bank, he would have been earning interest. By taking it out of his bank and buying the car, he no longer gets that stream of interest. So he's actually paying interest because he's taking that money and used it on a car, instead of leaving it in the bank where it was a growing asset. You, on the other hand, you're going to have to pay real interest. Okay, explicitly, but he's really implicitly paying interest too. And that's really the fundamental concept of opportunity cost. We're going to look at firms and we're going to find out that to economists that good managers ask the following question. An accountant walks in and lays down on the desk, boss, I just did the books. For the third quarter, we made $3 million profit, congratulations, you really are a great CEO. Accountant turns around walks out. Economist says, the good managers ask the very first questions. Yeah, but what could I have done if I was doing something else? What if I took the assets of this company, liquidated them, and started making Twinkies instead? Maybe I could make more money elsewhere. Good businesses are constantly evaluating, sure, I made $3 million here, but maybe I would have made $4 million if I went into that line of business. So opportunity cost is fundamentally crucial to us thinking about why people make decisions in the marketplace, and why firms make decisions where they're going to operate or where they're not going to operate, thanks.
