Cost Is Objective

The Market’s Measuring Stick Isn’t in Your Head

Economics underwent a fundamental shift at the turn of the twentieth century. Sometimes called the “Marginalist Revolution,” this transformation saw the discipline move away from a view of prices as rooted in intrinsic factors, like labor time or “use value,” and toward the insight that prices reflect individuals’ subjective preferences. Economists Carl Menger, William Stanley Jevons, and Léon Walras taught us that utility (the satisfaction we gain from consuming a good or service) is, by its very nature, a subjective, psychological phenomenon. This was a crucial breakthrough for understanding exchange and the dynamics of markets.

However, embracing the subjectivity of utility has led some economists to mistakenly conclude that economic cost must also be purely subjective. In reality, while utility reflects personal satisfaction, cost tends to involve real, objective sacrifices. These are losses whose value can be measured in concrete terms. A clear understanding of markets requires recognizing that, while subjectivism has its place in economics, it also has its limits.

Subjective Utility vs. Objective Cost

It is undeniable that utility is subjective. You and I will derive different degrees of satisfaction from the same product. One of us might value his morning cup of coffee above nearly anything else consumed that day, while the other prefers tea or forgoing caffeinated beverages altogether. Yet when we talk about cost, we are translating such subjective preferences into an observable, objective metric: dollars (or whatever the relevant currency or standard of value happens to be).

Cost is fundamentally tied to willingness to pay (WTP) or willingness to accept (WTA). While different people’s degrees of satisfaction differ (that is the “subjective” part), the actual readiness to engage in payment or acceptance of a sum in exchange for a good or service is an objective phenomenon. It can be documented, measured, and aggregated. A person may say, “I would pay up to $100 for this new gadget.” That statement reflects a subjective preference, but the value in objective, monetary terms is $100 worth of goods or services to this person, despite the fact that utility is an underlying driver behind this valuation.

Private vs. Social Cost

Every individual faces a private cost for an action or for purchasing a good. It can be interpreted as: “How many dollars am I willing to hand over (or how many dollars must I be paid) for me to undertake this action (or refrain from it)?” This private cost relates to what the person must personally give up in order to obtain (or avoid losing) the item (which is their opportunity cost).

This does not mean that a poor person with a lower willingness-to-pay is necessarily getting less utility from a good. Their objective spending constraint is smaller. This underscores an important distinction, which is that cost and welfare (or utility) are not the same. Wealthier individuals can pay more easily than poorer ones. That complicates the connection between cost and utility (some pay a lot even though their utility gain might be modest, while others might obtain immense utility but cannot afford to pay as much). Nevertheless, our market system relies on this payment principle to determine how resources are allocated. Cost is a concept conceptually linked to the efficiency of markets.

Social cost, by extension, sums up the private costs across all individuals in society. It, too, is objective in the sense that if we could measure what everyone would pay (or must be paid) in dollar terms for a project to happen, that sum is the social value of the project. There is no inherent difference between costs and benefits as these can be viewed as two sides of the same coin, and they are both valued in terms of their opportunity cost to society. The fact that it is often difficult to measure these numbers does not mean that cost ceases to be objective. The challenge is methodological, not conceptual.

Opportunity Cost and the Role of the Counterfactual

Opportunity cost is famously described in textbooks as “the value of the next best alternative.” This is not precisely correct, at least not universally. A better way to put it is: opportunity cost is “the value of what would have happened otherwise.” In many (especially simplified) economic models, the relevant counterfactual is indeed the “next best alternative.” But in the real world, the counterfactual could involve some alternative that is not strictly this second-place choice. The key is that opportunity cost is tied to the counterfactual scenario—what would happen otherwise—rather than necessarily a ranked list of discrete alternatives.

Recognizing that cost reflects the foregone scenario you might have pursued, we see again that cost is objective in the sense of “What would you have done instead, and what is that worth in dollar terms?” What would have happened is an objective fact and we can put a price on it, even if identifying that counterfactual is challenging.

The Confusion over “Subjectivism” in Cost

Historically, certain subjectivist approaches (for example, from economist James Buchanan) have blurred the line between cost and the act of choice itself. Buchanan’s subjectivist economics emphasized the idea that the individual, at the moment of choice, experiences cost in a subjective, psychological sense (sacrificing some utility by forgoing something in favor of pursuing some other preferred course of action).

But in standard, modern economics, the objective measurement of cost is precisely the external, theoretically optimal price associated with the sacrificed good or action. The decision-making process may be subjective, but the economic cost is not.

Buchanan’s emphasis on choice was not a particularly helpful intellectual contribution. His approach has led many economists astray and caused them to downplay the real resource costs associated with public and private decision making. I believe where Buchanan erred is in thinking of opportunity cost as “the very best alternative,” and believing this must be something that is unique to each and every person and impossible to measure empirically, because each individual’s ranking of alternatives exists only in the mind.

However, as already noted, one need not know a person’s complete ranking of alternatives to understand an action’s opportunity cost. The opportunity cost of an action consists of only one alternative: the foregone alternative. Identifying more efficient alternatives can still be important, but we should not confuse this exercise with an action’s opportunity cost.

It is not hard to see why Buchanan’s approach has yielded confusion. For good reason, mainstream economics has for the most part downplayed or ignored Buchanan’s writings on these topics. It is only a minority of economists who still tend to adhere to his perspective.

Why “Free Lunches” Can Exist

Economists sometimes say, “There’s no such thing as a free lunch.” Yet free lunches can exist, provided you interpret them correctly. A “free lunch” occurs when an activity is generating negative social value—that is, the external costs it imposes on society outweigh its benefits, or it offers no social benefit whatsoever. Stopping such activity (assuming there’s no major cost to doing so) yields negative social cost. We essentially give up nothing to free up resources that are unproductively used.

Why do such situations persist? One reason is “transaction costs,” which is a catch-all category for any frictions that prevent obviously beneficial market exchanges from transpiring. The inability of future generations to participate in current markets is one obvious source of transaction cost; others might be inertia, poor incentives, or “unproductive entrepreneurship.” People can become locked into negative-sum activities for a host of self-interested, political, or psychological reasons.

Libertarians sometimes bristle at these kinds of observations. They fear that labeling certain activities as worthless or generating negative social value might justify paternalism or forcibly shutting those activities down. My take is more agnostic. From a purely economic perspective, if someone is inflicting harm and eliminating their activity is relatively costless, that can be viewed as a “free lunch.” I will leave it to others to determine the policy implications of this economic fact. It is not up to economics to reject facts based on their policy implications.

Measurement Challenges Do Not Undo Objectivity

Skeptics of cost-benefit analysis sometimes point out the difficulties associated with concepts like willingness to pay, willingness to accept, or the proper numeraire (e.g., should we use dollars, euros, or something else, like apples or bananas to measure value). It is true that the choice between WTP and WTA and the choice of measurement unit can indeed shape numerical estimates of cost. Nevertheless, those complications do not change the fact that cost itself is an objective phenomenon. If markets were perfect and complete, then every good and service would have a well-defined price that perfectly reflected its value to society at a particular moment in time. Likewise, every individual would have some reservation price, which captures the dividing line delineating the point at which a transaction would and would not occur. Discovering these “shadow prices” may be fraught with difficulties, but the objectivity of the underlying concepts remains.

Concluding Thoughts

The Marginalist Revolution taught us that subjective utility is the underlying basis of individual valuation and market prices. But from that, it does not follow that economic cost must also be purely subjective. The modern economic conception of cost treats it as the translation of subjective utility into objective, monetary terms. This is the correct approach.

Distinguishing between utility and cost clarifies several thorny topics. Cost is a concept tied to market efficiency, while utility relates to an individual’s personal psychological experience. For valid reasons, some economists are more concerned with utility than efficiency. But it is also potentially the case that efficiency and welfare move together in the long run. The income of society tends to correlate with many other aspects of human well-being. Still, there can be large divergences between income and welfare in the short run.

In part due to this gap between short and long run interests, “free lunches” can sometimes be found. Different schools of thought might take this lesson and arrive at different normative conclusions. Economics itself is largely indifferent to those conclusions. Its job is to remain a neutral and objective science. No inherent normative conclusions can be drawn from an objective set of economic facts, as this requires a particular ideological framework applied to the facts.

At its best, economics is a positive science that aims to describe and analyze how real-world markets function. When we focus on objectively measurable phenomena, we avoid corrupting economics by injecting politics into it. Cost, whether private or social, can be measured, and while the measurement can be imperfect and subject to uncertainty, that does not undermine its fundamental objectivity. Cost, properly understood, is very much an objective fact about the world, even if other values other than cost also at times warrant our consideration.