Home › Forums › Discuss Austrian Economics, Step by Step › "All costs are opportunity costs"
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December 11, 2013 at 10:17 pm #18144
I’m pretty sure I’ve heard this somewhere, but can’t remember where. Regardless, is the (money) cost an entrepreneur pays for his factors of production an opportunity cost?
Two reasons I bring this up:
1) If it really is an opportunity cost, it would seem as if entrepreneurs instead pay higher than the “opportunity cost” because they have to bid more than their competitors (whose production processes are the opportunity cost)
2) I was thinking of the possibility that this instead could be a nonsensical comparison of money prices to subjective valuations.December 12, 2013 at 9:37 am #18145
Yes, the price an entrepreneur pays for a unit of a factor of production is the same price being paid by all the other entrepreneurs who are using the factor in their lines of production. If consumers increase their demands for one line of an entrepreneur’s production, then he can attract more of a factor of production buy offering a higher price. The higher price will then become the new market-clearing price that must be paid by all entrepreneurs. (In other words, the market demand for the factor has increased.) Units of the factor will move into the higher demand line of production and out of the least valuable alternative lines of production, which are being produced by other entrepreneurs. As output declines in the alternative lines of production, prices of output there will rise and the higher costs can once again be covered by revenues.
In the division of labor, economizing decision must take account of economic calculation, which can be done only in monetary terms. Economizing in society cannot be done in subjective valuations alone. Fundamentally, in making choices people are always comparing the subjective value of alternatives. But, to do so successfully, they must take into account the technical, objective features of the different means they might use in attaining their ends. When acting in the division of labor, people must also make use of monetary prices, which are objective features of the world, in making economizing choices.December 12, 2013 at 8:08 pm #18146
Hm, so I get what you’re saying, but it still seems like the actual cost the entrepreneur pays is higher than the opportunity cost. Even though, once demand goes up in one line of production, market demand for factors rises and thus prices for the factors of production increase all around, this new price is higher than the old price. The actual opportunity cost is the value of what would have been produced otherwise – and isn’t that equivalent to the previous cost?
If I’m right about that ^, I guess one possible answer is that the entrepreneur in the line of production where demand has increased, only has to increase his demand by an amount where the price increases to the point where the least valuable production line is making a net income of 0, which would mean the new price is in fact the correct opportunity cost?
What do you think about this? Appreciate your help as always!
Oh, one last thing: so the money costs entrepreneurs pay aren’t really opportunity costs, but instead, our best way of estimating opportunity costs, correct? Would this be something related to what Mises means when he points to the imperfection of money, when he states “The inadequacy of the monetary calculation of value does not have its mainspring in the fact that value is then calculated in terms of a universal medium of exchange, namely money, but rather in the fact that in this system it is exchange value and not subjective use value on which the calculation is based.” (Economic Calculation in the Socialist Commonwealth, p. 10)December 12, 2013 at 8:30 pm #18147
All values and costs considered in action are anticipations of the future, not facts of the past. The current prices of factors of production reflect entrepreneurs’s predictions of the revenue that will be generated in the future by their use in production today. Thus, any entrepreneur who buys an input today pays for the value that will be lost in the future from not using it in other lines of production today.
Monetary costs are not a method of estimating social opportunity costs, but the only manifestation of such costs because the subjective valuations made by different persons cannot be compared. There is no other method to determine the economizing use of resources for society at large.December 13, 2013 at 10:29 pm #18148
Thanks, Dr. Herbener! That makes sense, but I have one last clarification. I’m trying to integrate the bidding process and the equivalence of the price of a factor of production with opportunity cost in my mind.
“Thus, any entrepreneur who buys an input today pays for the value that will be lost in the future from not using it in other lines of production today.”
So if an entrepreneur who has increased demand for his product, bids for a resource (factor of production), increases the market price (of that factor), then the price he pays for it is equivalent to the value that the factor would have attained in the future, had it been used in the production process that has now been displaced by the production process with increased demand?
I think this is just a restatement of your quote. If so, is the price paid for the factor equivalent to the value of the displaced line of production, because at that price, the displaced line of production earns 0 profit (revenue=cost) and so no entrepreneur no longer wishes to do it?December 14, 2013 at 3:13 pm #18149
Yes, the displaced line of production no longer earns the going interest rate of return because costs have risen and revenues have not. The value of having the input in the expanded line exceeds its opportunity cost in the alternative displaced line of production. That is what justifies allocating the input into the expanded line of production and away from the displaced line of production.December 14, 2013 at 8:10 pm #18150
Appreciate your help, Dr. Herbener!
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