So back to the last blog and the quandary posed by David’s father—the developer, who made a good profit from developing his land ‘but he could never tell if he was putting the land to the best use’. Did David’s father get the best return on this piece of land, assuming he could do whatever he wanted to?
There’s a concept in economics called opportunity cost. I’ll see if I can articulate it coherently.
Take for example, going to the university to get an education and earning a degree. If you pack your bags and move into the institution for four years, most of your productive time will be spent in auditoriums, classrooms, labs, libraries and at your desk, studying either alone or in groups. (That’s when you’re not sleeping or eating and taking care of other social and bodily functions.) Putting your time into obtaining a formal education means you can’t be behind a counter ringing up the cash register, at a desk (and in front of a computer) doing whatever it is you’re hired to do or design fashion t-shirts. Part-time jobs in this example, don’t count.
There is a cost to your attending the university beyond the fees you pay. And that cost is measured by what you could have earned during those four years. That’s the opportunity cost. Lost income. But just in case while reading this, you now think that you ought to quit school and start working straightaway, be assured that on the whole, those with a university education earn more over the course of their career than those without a university degree. The amount you’ll receive over the course of your career will more than make up for the lost income experienced during those four years you’re in the university.
So back to the question: What could David’s father, the developer, have done with that piece of land, notwithstanding the handsome profit he made? Expressed in another way, the question takes this form: What’s the opportunity cost of developing the land?
Had he talked to a farmer, David’s father might have had a view into the income he could have generated growing certain premium fruit trees—durian, mangosteen or banana. Had he talked to someone who owned and operated a palm oil plantation he might know what he could bring in going down that road. Or had he consulted a theme park operator, he could have had another view. And who knows if there was oil beneath the ground or perhaps even gold. Unless David’s father consulted with different people, he couldn’t know ‘if he was putting the land to the best use’.
The funny thing is that, there’s an opportunity cost involved also in spending time finding the answer. Had David’s father conferred with the various consultants, he would be spending time with them and would have to leave the land temporarily dormant. There’s an opportunity cost to that. Perhaps, based on his own experience and knowledge of the property market, David’s father’s pursuit of developing the land and putting buildings on it that buyers wanted was the best decision, under the circumstances.
Economic theories and concepts undergird many of our fiscal decisions, from what we choose to sell (our labour and time) to what we choose to buy (mutual funds, shares in public-listed companies or properties). The better aware we’re of economic concepts and principles, the better positioned we are to make good thoughtful decisions instead of knee-jerk ones. They also give us a way to wrap our heads around the economic policies our country adopts.