competition and innovation

The free-market system not only encourages vari­ations in quality and price but also encourages immense variety in the types of goods and services offered to the public. Changes in popular taste, technology, the economy, and the competitive environment are constantly creating new business opportunities — and free enterprise, like nature, abhors a vac­uum. The possibility of profit, however remote it may be, almost invariably attracts entrepreneurs willing to risk their time or money. The result is an astonishing diversity of businesses. Almost anything you might want to buy—any productor service, no matter how obscure — is probably sold somewhere.

Comments:

Profit – money left over after expenses and taxes have been deducted from sums received from the sales of goods or services.

A firm’s profit is the amount left over after expenses have been deducted from sales.

Opportunity cost – value of using a resource, measured in terms of the value of the best alternative for using that resource.

bottom line 1. The line in a financial statement that shows net income or loss.

2. The final result or statement; upshot: "The bottom line, however, is that he has escaped" (David Wise).

3. The main or essential point: "A lot can happen between now and December, but the bottom line-for now-is that the city is still heading toward default" (New York).

The concept of "opportunity cost" is a basic building block of the study of economics. Why? Because economics is a science of human behavior, whose goal is to understand how people use the resources available to them to satisfy their desires. Those resources -- which economists classify into the categories of land, labor and wealth -- are limited. But human desires are not. We human beings have long understood ourselves to be "the unsatisfied animal". When our physical needs are well-satisfied, we seek to entertain, enlighten or challenge ourselves. Because human desires are unlimited, but the resources available to satisfy them are limited, we must make choices about how to utilize those resources.

To choose something is to pick it in favor something else. Economists call the value of the best thing not chosen the "opportunity cost". For example, if you have ten dollars to spend, you could either buy lunch with the money, or go to the movies. You might think one choice is obviously better -- but, of course, not everyone would agree with you. Someone else would buy a book with the $10; someone else would buy cigarettes; yet another person would donate the money to charity. Human beings desire a huge variety of things. Nevertheless, each thing we choose to spend our labor (or our money) on has an opportunity cost: the value of the best thing one didn't choose.

This all seems pretty obvious, so why is opportunity cost such a powerful concept? Because of its usefulness as an analytic tool. In a market economy, people seek to make a profit. To do that, they must utilize their resources as efficiently as they can, in order to bring back the greatest benefit to themselves. Many, many factors must be weighed. In making all those decisions, it is a great help to know the value of the next-best thing that one could have chosen. Let's say, for example, that we run a hot dog stand, and after a strong couple of weeks we have a net profit of $200. What would be the best way to utilize that $200 profit, to satisfy our desires?

To begin with, we'd have to be clear about what those desires are! We could close up shop and throw a big party -- but when the party was over, we would be right back where we started. We could buy more supplies to sell, or invest in another stand, or hire an employee to help sell the hot dogs. We could introduce a new line of burgers to go along with our dogs. We could invest in an advertising campaign. Choosing any one of those alternatives would leave us less able to pursue any of the others. To make a smart decision, we would have to tally up the value we would lose by making any of the choices. What we would be doing, in economic terms, would be using the analytical tool of opportunity costs to construct a model of potential outcomes.

Society as a whole also weighs opportunity costs in many ways. Governments must make decisions on tax policies and spending for public goods. For example, spending public funds to build a highway means that we cannot use that same money to build a railroad. Similarly, if taxes are cut and less money comes into the Treasury, consumers have more money to spend -- but the opportunity cost is the national services or programs that could have been funded with that revenue.

There is one giant opportunity cost to society as a whole that is seldom considered, but has tremendous consequences in all areas of our economy. That is the phenomenon of land speculation. This practice -- that of holding valuable land out of use until the owner deems it most profitable -- creates huge problems for cities, public infrastructure cost, community vitality and environmental health. It is a primary cause of the dual problems of urban blight and suburban sprawl. Land speculation is a practice that is very widespread in modern economies, yet brings society as a whole no benefits, but many costs.

It is interesting to note that the landowner's view of the opportunity cost of land speculation is exactly the reverse of the society's view. For the landowner, the opportunity cost of using land today is the higher price or profit that could be gained in the future -- and since land tends to increase in value as population and production increase, there is a built-in incentive to wait! Yet, for society at large, the opportunity cost of valuable land being withheld from use is both the production and employment that doesn't happen on that site, and the cost of providing services and infrastructure to a less-suitable site, farther from where the action is!

Let's compare the situation of the land speculator with that of the hot-dog business we discussed earlier. Clearly, our hot dogs were in demand. Did we have any reason to hold them off the market, waiting for higher prices? No! Someone else would have come in and sold hot dogs, while ours got stale. Our incentive was to invest in ways to get more and better dogs to more customers. And society as a whole benefited: because of competition among hotdog vendors, consumers got better hot dogs at cheaper prices than they would have otherwise. Competitive markets, then, benefit society as well as the successful businesspeople.

But as we have seen, that is not so in the case of land speculators. They profit from an activity that actually harms society. This phenomenon -- when an individual entrepreneur profits from an activity that harms the overall community -- is what economists call "market failure". The question of what to do about instances of market failure is one of the most basic questions of economic policy.

Another way to think about the notion of opportunity costs is to remember that human desires are unlimited, and people seek to satisfy their desires with the least exertion. Thus, we all must make choices about how we wish to use our labor, and the products of our labor, to get what we want.

Background Questions

1. What are the three categories of economic resources?

2. Explain and give one example of opportunity cost.

3. How do competitive markets benefit society?

4. How is land speculation an example of market failure?

5. What are some of the effects of urban sprawl?

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