September 14, 2020 Reading Time: 4 minutes

Many economics lessons are treated as one-off curiosities, rather than insights into how the world works. I have been frustrated, for example, at the ability of students to recite the definition of opportunity cost accurately, and yet fail utterly to understand its implications. I wrote about this a while back in describing a test question I gave at Dartmouth College when I was teaching there in the 1980s: Suppose you want to go to a concert, but decide not to buy from a scalper because the tickets are too expensive. But then you find some tickets; do you go to the concert?

No! The cost of going to the concert is what you give up. In this case that’s the value of selling the tickets (the question posited that scalping is legal in your state, and you have no moral objection). It doesn’t matter what you paid for the tickets, folks. The cost is what you give up by using the tickets. If you wouldn’t pay the $250 for the tickets to buy them, why would you pay the opportunity cost of failing to sell them once you have them in your hand? (A footnote: yes, there could be a wealth effect, or a transaction cost difference, that would imply different answers. But that’s not what the students said. The students said they would go to the conference because it was free!)

An even more fundamental concept, one that almost anyone who has had a sophomore economics class can recite from memory, is the resolution to the “diamonds and water paradox.” In the Wealth of Nations, Adam Smith put the puzzle this way:

The word value, it is to be observed, has two different meanings, and sometimes expresses the utility of some particular object, and sometimes the power of purchasing other goods which the possession of that object conveys…. Nothing is more useful than water: but it will purchase scarce anything; scarce anything can be had in exchange for it. A diamond, on the contrary, has scarce any value in use; but a very great quantity of other goods may frequently be had in exchange for it.

The resolution of the paradox is simply that value is subjective, and marginal. There are circumstances when my want for water might exceed my want for diamonds, but only if there were a deadly shortage of water, making slaking my thirst my primary concern. Usually, at least in developed nations, water is plentiful and large amounts can be obtained for a very small price. At the margin, then, the thousandth gallon of water is worth much less than the first small diamond I purchase to adorn the neck or finger of a loved one. In this short clip, Murray Rothbard is able to solve the problem neatly and quickly; it’s not a paradox at all.

But the point was never to explain the relative values of water and diamonds; the point was to explain the relationship between price and value. Since economics teachers recite the example as if it were scripture, but fail to give students an understanding of the importance of marginal value, we are doomed to have to read and hear egregious intellectual indignities committed by people who should know better.

Examples are easily found. Some version of “teachers are more important than athletes, so they should make more money” is written up weekly among the professional sellers of outrage that populate our media. The New York Times is especially indignant, often proposing state regulation or some kind of “special tax” to solve the problem. (It’s always a “special” tax with these people; the fact that we already pay substantial taxes that could be used to raise teacher salaries if there any political will to do so never seems to come up).

When Steph Curry, my Davidson College homeboy, signed with Golden State for $40 million per season, the tut-tutters were out in force. Curry was getting paid $500,000 per game, or ten times what teachers make in a full year’s salary! Tut tut!

Gosh. If you were building an NBA team, you wouldn’t start with marginal players, you would start with the best, the diamonds. There are a few elite players, often referred to only by their first names (“LeBron,” “Giannis,” “Dirk”) that you might build a team around. Signing them first is expensive. Then as you add marginal players, the cost is less. Of course, the relevant margin is not the worst player in the NBA; it’s not even the best player who failed to make the NBA.

No, the marginal player is the one who has a negative salary, the 40 year-old guy who pays for a membership at the YMCA or college gym to play basketball. Those folks are not being paid more than teachers, because there are tens of thousands of those foul-hacking, can’t shoot with a hand in their face, smaller than baller gym rats. 

Marginal basketball players are paying $65 a month to play, compared to at least $4,000 per month monthly salary for experienced teachers in most states. Basketball players are not paid more than teachers; the entire complaint is a basic confusion over an example that everyone thinks they learned, but didn’t actually understand.

As an educator myself, I am happy to grant that teachers produce value for students, and for society. But even the most marginal teacher, at the worst and least motivated public school, can’t-wait-for-retirement clock puncher, makes far more than the marginal basketball player. You can’t compare the marginal unit of water, or teachers, with diamonds. That’s a paradox we solved long ago.

Michael Munger

Michael Munger

Michael Munger is a Professor of Political Science, Economics, and Public Policy at Duke University and Senior Fellow of the American Institute for Economic Research.

His degrees are from Davidson College, Washingon University in St. Louis, and Washington University.

Munger’s research interests include regulation, political institutions, and political economy.

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