When considering the various components of a free market: scarcity, choice, and opportunity cost, I am struck by realities that run concurrent with one another. Scarcity has historically been understood both within the scope of economic models, anecdotal data, and the gut level experiences inherently known by every adult and businessperson. As a standard economics text points out, resources function as “instruments provided by nature or by people that are used to create goods and services” that are inherently limited. This means the law of opportunity cost often discussed in finance is constantly at work – whether at the level of an individual, a firm, a government or an entire market or economy. It is the constant decision of the “next best alternative” versus the one in front of us that occupies much of our time, mental energy and business planning. I have been a part of several firms over the years where various request for proposals for municipal contracts are on the table, and each of which will take tremendous research and labor output to consider and bid. In the end, we boil all this down to one simple question, “do the numbers make sense?” This is not a question of whether we can get the contract necessarily, or even if we might turn an honest penny having done so. The question is, for stakeholders and executive leaders of the firm or the organization, does the profit (or benefit in the case of governmental/non-for-profit enterprise) of that new business unit outstrip the output of energy required to run it? Or will it turn out to be a mental vacuum that could lead to damage of much more valuable business entities? I would say this scenario falls within the traditional understanding of opportunity cost for many common endeavors.
Another consideration is where we find ourselves in our present state of the economy, employment and outlook for the future. In spite of the economy being years officially out of recession, there are still significant systemic problems still very closely related to unemployment. This throws a wrench in the model of scarcity, cost and efficiency. The prolonged nature of current unemployed ranks is still driving what feels like a consumer led recession. This continues to be part of the wreckage of what happened in our country in the last 10 years, particularly as our economy has been fueled by debt, only to be followed by policies that closely resemble those that enabled the dysfunction to begin with. Several years ago I came across this in my economics text, (though on a slightly different point) “sometimes the market does not function well and hence assigns prices that do not accurately reflect opportunity costs.” Would you say current asset inflation reflects this? Years ago when I read the above quote I could not think of anything other than real estate, the cheap cost of funds, and the all too available credit to everyone. But those days are long behind us. The asset inflation is for different yet very similar reasons, ultimately because of increased liquidity. Our markets are (and I guess always have been [based on my historical reading]) addicted to asset bubbles.
Baumol, W. & Blinder, A. (2010). Economics: Principles & Policy (11th ed.). Mason, OH: South-Western Cengage Learning.