Note: This post was authored by Steven Baker
Since reading Henry Hazlitt’s Economics in One Lesson an important concept leapt out at me as one that many people do not, yet really ought to. Once you grasp this concept, I doubt you will be able to argue against it. And you’ll see things in a whole new light.
The concept is the “broken window fallacy,” and it does the best job of illustrating the importance of the concept of opportunity cost (and making the case against Keynesianism).
Don’t Go Breaking Any Windows
Before I get into the explaining the broken window fallacy, let’s review the concept of opportunity cost.
The idea behind this is that you can only buy a certain number of things (your needs and your wants) with the limited amount of money you have. Let’s say you have $100 and there are two things you want: one is $100 and the other is $80.
Clearly you can only afford to buy one of them. So you think about it for a while and decide the best outcome is for you to buy the $80 item (whatever it may be). The opportunity to buy the $100 item is now gone, since you no longer have enough money.
Since you chose the $80 item as the best choice, you have subjectively prioritised the items from best to worst, and chosen the best for you. The $100 item is what you would call the next best alternative. The opportunity cost is defined as the cost of the next best alternative forgone.
Even in a world where everything is “free,” there would be opportunity costs in the form of the time consumed in enjoying certain tasks over another.
The Broken Window Fallacy
To retell Hazlitt’s variant of the broken window fallacy; that there was a baker with a shop where delicious pastries, cakes and sweets were displayed in the front window. Passers-by enjoyed looking through at the tasty treats.
One night when all the shops had closed and everyone had gone home for the evening, a local deviant boy came along with a large rock, and hurled it through the bakery window, shattering it completely.
The next morning, the baker arrived at his shop to find the smashed window. Incandescent, his neighbour tried to calm him. He saw a silver lining.
“What would become of the glaziers if panes of glass were never broken?”
Considering the thought, the baker replied “That is true, this does help the glazier. But I expect this will cost me over $1,000 and I was saving up to take my family on a nice holiday! There goes that idea!”
At this point we can see that the baker has two different alternatives:
- Forget about taking his family on holiday and get the window repaired so he can continue running his business; or
- Ignore the broken window and attempt to run his bakery without it, meanwhile leaving the bakery with a broken front window while he takes his family on holiday.
Remember opportunity cost above: the baker only has enough money for one option and he must make the best choice for himself. Obviously the choice is to get the window repaired immediately.
Enter the glazier.
The baker organised for the glazier to come and repair the window as soon as was possible. The baker was spot on with his guess, and the bill came to a nice round $1,000. The baker paid the glazier who had benefited nicely from the young hooligan’s actions. And there’s a supposed multiplier effect from this. The glazier will spend that $1,000 on something else, perhaps a new suit, providing a tailor with $1,000 to spend on whatever he wants, and so on and so forth.
But what would’ve happened if that window was never broken? The $1,000 would’ve been spent anyway, the money would’ve still cycled through the economy, and society would be one window better off in the process.
Mr Gain, Mr Loss, and Miss Doubt
I’ve pinched these names from Dominic Frisby’s book Life After The State—a book which originally inspired me to write about this—the three players here are Mr Gain (the glazier), Mr Loss (the baker) and Miss Doubt (the travel agent). For those of you who haven’t clicked, Miss Doubt = missed out.
Due to the actions of the hooligan boy, the glazier has become better off with what really should have gone to the travel agent, had the destruction never happened. The secret inherent in the story is that in life, nobody ever considers the travel agent who missed out or the baker who didn’t spend his money on his preferred option.
Think about it. Mr Gain, whoever that may be, has benefited from the circumstances and Mr Loss and Miss Doubt have not. They may even be worse off.
That is the important point of the story, and one that you can extrapolate out to cover the whole town, city, country and world. It’s one you could even compare to your own circumstances right now!
Most people would think that there isn’t anyone who misses out. Their thoughts would end at the baker, and I could imagine many people saying “toughen up, mate! That’s life!” about having to pay for the broken window. But never would they consider the opportunity cost of the situation.
Now you understand this concept, look around in the news and other places to see if you can identify occasions where this may be happening. You can extrapolate it out across the entire world economy.
Once you see it, you can’t help but imagine how much better the world would be if the Mr Gains of the world were not benefiting so much, and the Mr Losses and Miss Doubts got to spend and invest their money in a way that was better for them.
Therein lies the fallacy. On the face of it, it seems like since the glazier got $1,000 of work, its a positive thing. But digging deeper, we’re left with an overall negative situation.