What is the problem with this opportunity cost example?

Question

The "stand-up economist" Yoram Bauman used the concept of opportunity cost to make the following joke:

[S]omebody offers you a choice between a Snickers bar and a package of M&Ms. Suppose, for the sake of argument, that you take the M&Ms. According to Mankiw, the cost of those M&Ms is the Snickers bar that you had to give up to get the M&Ms. Your gain from this situation—what economists call “economic profit”—is therefore the difference between the value you gain from getting the M&Ms (say, \$.75) and the value you lose from giving up the Snickers bar (say, \$.40). In other words, your economic profit is only \$.35. Although you value the M&Ms at \$.75, having the choice of the Snickers bar reduces your gain by \$.40….

Indeed, the more choices you have, the worse off you are. The worst situation of all would be somebody coming up to you and offering you a choice between two identical packages of M&Ms. Since choosing one package (which you value at \$.75) means giving up the other package (which you also value at \$.75), your economic profit is exactly zero! So being offered a choice between two identical packages of M&Ms is in fact equivalent to being offered nothing.

There are two problematic claims here:

1. Being offered a choice between two identical packages of M&Ms is equivalent to being offered nothing.

The resolution to this is, I think, fairly straightforward - Bauman is intertwining utility and opportunity cost in a deliberately erroneous manner. In most standard utility functions, one's utility depends on absolute consumption rather than the value of the next best alternative. As such, one's utility from a choice between two identical packages of M&Ms is identical to utility from one package of M&Ms (without choice), and is strictly greater than consuming nothing at all.

2. The more choices you have, the worse off you are.

I'm having a hard time finding the exact problem with this statement as it is constructed in the joke. The reason is because consumer surplus (though not utility) does fall as the value of the next best alternative increases. As such, as long as new choices do not dominate the current best choice, additional choices can only decrease consumer surplus. What is wrong with this line of reasoning?

Answer 1

The joke is conflating the value of the item you get and the value of the option to determine which item you get.

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1. Suppose I value the Snickers at $\\\$.4$ and the M&Ms at $\\\$.75$. If I am offered a Snickers for free my economic profit is $\\\$.4$. If I could get the additional option to choose between the Snickers and a bag of M&Ms, rather than just get a Snickers for free, that would be worth an extra $\\\$.35$ to me. The entire event of getting the Snickers or a bag of M&Ms for free is still worth $\\\$.75$.
   
   If, instead of the Snickers, I was offered a free bag of M&Ms, then the additional option to choose from two identical bags of M&Ms would not yield any benefit. The economic profit resulting from the additional option to choose is indeed 0.
   Note that compared to getting nothing you are better off if you can choose from two identical bag of M&Ms, but you are not better off compared to getting one bag without the option to choose. This is how we could deduce the value of the option to choose.

2. Similarly, if your options broaden in a decision situation, it is possible that the additional benefit each new option yields diminishes. This is captured by the increasing opportunity cost. It does not mean that the entire value of getting to choose from a wide variety is approaching zero.

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I usually find that opportunity cost examples are overly complicated, perhaps to make the notion seem more intellectually demanding than it really is - therefore I can relate to the joke.

I used to teach microeconomics. With sunk costs it is important to get people to accept that the sunk costs are lost, hence doing something could be worthwhile even if the final outcome yields a loss, as long as the loss is smaller than the sunk cost.

In my experience most students understand the above two sentences perfectly, but they can be greatly confused when trying to pin down opportunity costs. Because of this I was never sure if this was a useful concept to teach.

Answer 2

1. First of all its all just joke so you should not read too much into it. Most jokes are based on some false/overly simplified premise.
2. You are right:

There are two problematic claims here:

Being offered a choice between two identical packages of M&Ms is equivalent to being offered nothing.

This is erroneous argument if for no other reason than that in such case there is no opportunity cost. In fact if you read papers on opportunity cost such as Buchanan (1991), opportunity cost requires some choice between mutually exclusive options. Thus having option M&M vs M&M is not an option at all. So in that case there is no opportunity cost.

Next you are also correct that your absolute utility depends on absolute consumption of goods and services.

In addition, the most valued option might not be in your original choice set. For example, you might value chocolate at whooping \$5. Thus if you expand your choice set you might discover that suddenly M&M is not the best option. It is also sometimes argued consumers have preferences for diversity where they derive utility just from having more options (e.g. monopolistic competition models with consumer preferences for product differentiation).

This being said you can construct games* or there are behavioral experiments that show that sometimes having more choices can be worse, and sometimes people might purposefully constrain their choices to deal with behavioral biases. For example, in response to hyperbolic discounting one might purposefully install some program that restricts your access to the internet when you want to study, but you know that you suffer from hyperbolic discounting. In addition, there is some experimental evidence from psychology that having more choice can be sometimes demotivating (see Iyengar & Lepper 2000), although I think results there can be interpreted with caution, it is possible that having more choice is not always strictly better in behavioral setting.

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_{* I recall seeing some examples of that in Tadelis Game Theory: An Introduction}