Session 01丨Define cost in one sentence

The concept of cost plays an important role in economics, and if you have a deep understanding of the concept of cost, then you can say that you are halfway to understanding economics.

In the United States, there has been a huge movement of "legal economics," which means that economists have been teaching economics to federal judges. This movement first began in 1976. The judges who took the economics class were so impressed that one of them said, "I've lived most of my life and no one has ever told me that everything has a cost. "

The concept of cost is important in economics, but it is often ignored by outsiders. It takes us quite a long time to talk about the concept of cost. Let's take it steady, one step at a time, and don't rush it.

Today, we continue along this main line to explain the concept of cost. Before that, I want to tell you a real story.

1. The story of the quarry

I have a friend who owns a quarry, specializing in quarrying rocks. One day, he invited us to play in the quarry, and we found that he bought a piece of vacant land next to the quarry, which had a fish pond and a small forest on it, which was quite fun. We asked him, you bought this land to sell fish, or to develop real estate?

He said, "I neither intend to sell fish, nor to develop it as a tourist area, nor to develop real estate, I bought this piece of land just to leave it empty."

That's strange, why buy a piece of land and leave it empty? There is a reason for that. Because he knew that he was in the business of quarrying, and having this piece of land next to him empty would always attract some property developers. If the real estate developers buy this land and build residential, residents who live in, will certainly complain about the noise from the quarry, which will then have an impact on his quarry business.

Of course, if this matter is taken to court, my friend will not necessarily lose the case, because after all, it is still the residents themselves who moved there, they asked for it. But you know, where there is a lawsuit, the outcome of the lawsuit is uncertain. He wants stability, he wants his business to be able to be stable, so he buys the vacant land and does not develop anything.

2. The entrepreneur is the middleman of resource allocation

The first time I told this story to my students was when I was introducing the concept of tort law. A female student said to me after class, "Mr. Xue, your friend bought a piece of land and didn't use it, you know, the housing price in Beijing is already quite high, if everyone is like him, if they buy land and don't use it, it will make the housing price rise further, so I think your friend is quite selfish. So I think your friend is quite selfish."

My first feeling was that this student did not understand the crux of the question. Then I thought about it, and this student's question is also quite interesting, since then, I will use this example as the beginning of my explanation of the concept of cost every time.

So let me ask you, is this student of mine right? Is my friend a selfish person? You may also defend my friend and say that it is not selfish, he is after all spending his own money and he can do whatever he likes. But then I will ask you, did my friend pay for this land? You will say: Yes, Mr. Xue, didn't you just say that your friend bought it?

I'll ask you again: Do you think my friend bought this land? You have to think about why my friend is willing to produce the stone. He didn't want to produce stones for no reason, but because someone was willing to buy them, right?

He bought the land, ostensibly because he paid for it himself, but in reality, he was willing to pay for it because he was convinced that someone would pay for it for him, and that was the person who bought the stone. Thinking further, did the buyer of the stone buy the stone for no reason? No, he bought the stone to build a museum. Because he believes that someone will be willing to pay to visit the museum.

So, layer by layer, you will find that what we can see is that my friend paid real money to buy the land, and what we can't see is that there are consumers who are willing to pay for the stone in the end. It was the consumer who bought the land in the end.

My friend was just a middleman. He was only buying the land by making a reasonable guess that someone would eventually be willing to pay for it. At this point, my friend is an invisible auctioneer.

consumers are willing to pay for their business activities. If the guess is right, society does not need to reward him, he has been rewarded, that is the money he earned; if the guess is wrong, he does not need to admit his mistake, because he has lost money, the loss is the appropriate punishment.

3. the cost is the biggest price to give up

One of the economic lessons of my friend's purchase of this vacant lot is that we need to see that this vacant lot is an important raw material for his smooth production of stone. This friend was a stealth auctioneer and was faced with two choices.

He was guessing whether the land would be better used for stone or for building a house. The reason he was willing to pay for the land and let it be used as raw material for stone quarrying was that he believed that the land would be used for stone quarrying and that the future returns would be higher than taking the land to build a house.

What will happen if the price of residential housing rises high enough at this time? Will my friend continue to quarry stone? No, he will not. He will close the quarry and take the land to build a house.

There are two competing uses for the land: either a quarry or a residential area. Which use wins will depend on which of the two uses is the higher bidder.

These two uses are, let's say now, two kinds of people: those who visit the museum and those who want to live in the houses. They can be two sets of people. But in fact, they can also be the same person. A person can have two needs at the same time, and he has to make a trade-off, a trade-off between these two needs. This is when the concept of the cost comes out naturally: cost is the maximum cost of giving up.

If this piece of land is used to build a museum, then the residential building is given up, and the cost of building the museum is the residential building that was not built; if the other way around, if this piece of land is used to build a residential building, then the museum will not be built, and the cost of building the residential building is the museum that was given up.

Let's make this concept a little clearer. A piece of land can be used not only for museums or residential buildings but also for many other purposes: A, B, C, D, E. Let's simplify it by saying that there are only these two uses: building museums or residential buildings. If you build a museum, you can't use it for a private house, and a private house is the cost of building a museum; conversely, if you build a private house, you can't do a museum, and a museum is a cost of building a private house.

A resource has several options, and the option that is selected is the one that has the highest value among all the options that are not selected. Simply put, the cost is the maximum cost of giving up. 4.

4. the concept of cost seems simple, but it is unfathomable

An example I remember very well is what happened during the college entrance exam. I remember that a few days before I took the university entrance exam, my family was very obedient to me, and because of the high value my time might generate, they didn't let me do any chores. When I finished my last exam and came home, as soon as I put my book bag down, my dad called out to me and he said, "Zhaofeng, go take out the garbage." You see, the opportunity to choose is different, the cost is different, and this is the concept of cost.

You may say, the concept of cost is quite interesting, but it sounds so simple, that I can understand it. But in fact, the concept of cost can be described as unfathomable.

Why? Look carefully at this sentence: "The option with the highest value among the many options that have been given up. Now the question is, all the abandoned options, it is not realized? How do you know what you've given up if you haven't achieved it?

What you have given up is not realized, you have to imagine to know how valuable it is. This imaginary space has attracted many great economists to work hard on the concept of cost. They include.

Frank Knight (Frank Knight)

Ronald H. Coase

Armen Alchian

James M. Buchanan

Gordon Tullock

These economists, who have fully explored this imaginative space, have broadened our understanding of the world to an unprecedented degree.

For example, the costs of public goods, the costs of institutional change, the costs to society, and the costs of the competition itself. Some of them have won Nobel Prizes for their work. If you are not familiar with the economists mentioned earlier, you can search for their names in English and Chinese, and go online to gossip about their stories.