As we make everyday choices—how much time to spend working or studying, what to spend our money on—we are experiencing what economists call trade-offs and opportunity costs. A trade-off is when we choose one option in favor of another and the opportunity cost is what is sacrificed in order to get something. Whether we realize it or not, we are constantly evaluating the costs and benefits of each decision we make; therefore, it can also be said that we are performing our own cost-benefit analysis each time we make a choice.
As decisions are made—either individually or as a society—we constantly make trade-offs in order to get more of one thing by giving up another. The saying ?time is money? illustrates this point. If we ?consume’ more free time, we are left with less money due to the fact that we are not earning money from using the time to work. The opposite is true as well; if we want more money, we must put in more work hours to get it; therefore there is less free time available. When we consider time and money, and graph the combinations for where one has no preference of one over the other, we come up with an indifference curve, such as the one below.
On the graph, X is the point where we have an even balance of time and money; yet an indifference curve is such that one is equally satisfied at any point along the curve. Therefore, we could move to point A, where we would have a lot more time but less money, or we could move to point B, with a lot more money but less time, and we would be equally satisfied. The slope of the indifference curve is based on the marginal utility of each decision; each successive move towards an axis comes at a higher price. For example, at point B we require more money for each unit of time than we do at point X because our time is more valuable since we have less of it. Therefore, we will begin to experience diminishing marginal utility.
The economy and the environment are inextricably linked. Whether we are looking at daily life or natural resources, because resources are scarce, choices have to be made about how to use them. The basic fact is that resources used to meet one choice or alternative cannot be used to meet another. Just like how we value regular goods, the valuation of natural resources and the environment is based on how we value their services and, for services that are consumed directly, that value is based on our utility and willingness to pay for a certain amount of the services.
The decision about how to allocate resources relating to the environment has an impact on all sectors of the economy, primarily because of the complex relationship between utilizing natural resources and economic output. Many times, the cost of utilizing these resources and/or services include direct costs as well as opportunity and external costs, which are not traded in markets or assessed directly in monetary terms. For example, when trees are cut for such uses as housing and furniture, some of the direct costs will include the cost of machinery and labor during cutting, processing, and manufacturing. The opportunity costs relating to this use would be the opportunities foregone by the machinery and labor that could not be used elsewhere, since it was occupied cutting trees. The external costs are the loss of environmental benefits that are no longer realized which may include a loss in watershed management services, species protection, and CO2 reduction.
Many economists and policymakers agree that in most cases the market is the best way to determine the allocation of resources. The demand for various products and the availability of natural resources—along with a number of other factors, including preferences, the number of buyers and sellers, pricing, alternative choices, etc—is expected to lead to an efficient result of actual supply and demand. However, markets can fail to account for the full cost of a natural resource and/or related services, which will prevent it from efficiently allocating the resource and lead to externalities.
To reduce the potential for market failures and their resulting externalities, planners and policymakers attempt to identify a course of action that generates the greatest societal benefits. Much of this is done by using a mix of policy and strategies, including regulation, taxes, permits, access restrictions, etc. It is finding the appropriate balance between utilizing our natural resources and meeting the demands of society that will allow us to continue to expand our economy while sustaining our natural resources and the environment.
Updated by Dawn Anderson
Full Cost Accounting in Environmental Decision-Making
David W. Carter, Larry Perruso, and Donna J. Lee from the University of Florida write about this important issue in environmental economics, in which governments, businesses, and individuals make decisions that should take into consideration all of the trade-offs when calculating the most efficient and economic choice.
U.S. EPA: Engineering Trade-Offs
The Environmental Protection Agency established a program to assist decision-makers in evaluating the various trade-offs when making choices. They include consideration for environmental impacts, effectiveness, efficiency, and people affected.
This website clearly explains the concept of opportunity cost, providing examples and applications to clarify understanding.
Environment-Economy Trade-Offs and Forest Environmentalism
Carl Hand and Ginger Macheski from Valdosta State University examine how the public views forest management in this 2003 article from the Electronic Green Journal. The authors asked participants to weigh the importance of conservation versus the economy, and found that most people wanted both aspects considered, with slightly more emphasis on the environment.
For the Classroom
This activity, part of an Energy Education Curriculum Project developed at the University of Northern Iowa, has students learning about energy trade-offs by taking on roles of various countries. Students work to trade their resources among the various countries and finish with a discussion about the reality underlying the activity. [Grades 6-8]
EconEdLink: It’s a Matter of Power
In this lesson, students get the chance to make decisions as to whether Kaiser Aluminum should continue to produce aluminum or switch to selling electricity. Students will learn about trade-offs and opportunity costs as they read about and examine various options. [Grades 9-12]
Using Maps to Evaluate Environmental Trade-Offs
Students can participate in this activity to learn about environmentally sensitive coastal areas and the decisions that must be made to protect them in the case of an oil spill. [Grades 6-12]
Kolstad, Charles D. Environmental Economics. Oxford University Press, New York, 2000.
Opportunity Cost, The Concise Encyclopedia of Economics.
Trade-Offs, from A Glossary of Political Economy Terms, Dr. Paul M. Johnson, Auburn University.