Origin of the Idea

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2.1 Opportunity Cost

Friedrich von Wieser (1851-1926) first articulated the notion of "opportunity cost" (also referred to as the "alternative-cost" concept) in 1914. Wieser, who born and studied in Vienna, Austria, belonged to a group of economists known as the "Austrian Trio," who built on the growing tradition of marginal analysis. Friedrich von Wieser claimed that:

"Whenever the business man speaks of incurring costs, he has in mind the quantity of productive means required to achieve a certain end; but the associated idea of a sacrifice which his efforts demand is also aroused. In what does this sacrifice consist? What, for example, is the cost to the producer of devoting certain quantities of iron from his supply to the manufacture of some specific product? The sacrifice consists in the exclusion or limitation of possibilities by which other products might have been turned out, had the material not been devoted to one particular product. Our definition in an earlier connection made clear that cost-productive-means are productive agents which are widely scattered and have manifold uses. As such they promise a profitable yield in many directions. But the realization of one of these necessarily involves a loss of all the others. It is this sacrifice that is predicated in the concept of costs: the costs of production or the quantities of cost-productive-means required for a given product and thus withheld from other uses."(1)

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Friedrich von Wieser did not invent opportunity costs, he merely formalized the concept for us. Every decision involves an assessment of the opportunity costs involved, and most people make that assessment without ever knowing the term or formal concept.

Photograph courtesy of: (c)Nance Trueworthy;

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2.2 "Laissez-faire"

While Classical economists such as Adam Smith are famous for their economic philosophy of laissez-faire, the term originated with a group of French economists known as Physiocrats. The full phrase, "laissez-faire, laissez-passer," is credited to Vincent de Gournay, and in modern translation means "let people do as they please without government interference." More literally translated from the French, "laissez-faire" means "to allow to do" or "non-interference," while laissez-passer means "to permit." (1)

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The laissez-faire principle of freedom in economic affairs became part of Classical economics as a result of Adam Smith's study of the Physiocrats and his close association with the Physiocrats Francois Quesnay (1694-1774) and Anne Robert Jacques Turgot (1727-1781).

Classical economist John Stuart Mill (1806-1873) defends the concept in his "On the Influence of Government." He states,

In all the more advanced communities, the great majority of things are worse done by the intervention of government, than the individuals most interested in the matter would do them, or cause them to be done, if left to themselves. The grounds of this truth are expressed with tolerable exactness in the popular dictum, that people understand their own business and their own interests better, and care for them more, than the government does, or can be expected to do so. ⁽²⁾

Born in London, England, on May 20, 1806, John was the eldest of nine children of James Mill, a prominent philosopher, statesman, and political economist. James Mill believed that all people are born with equal ability, so he carefully supervised his son's education. John's intense education included Greek, Latin, philosophy, history, mathematics, and political economy, and he was writing and publishing works by his mid-teens. When he was twenty he suffered from what some would consider a well-deserved nervous breakdown.

John Stuart Mill influenced economics students for decades. In 1848 he published Principles of Political Economy, the leading textbook in the discipline for over forty years. Trained in Classical economic thought, but with the humanitarian influence he credited to his wife, Harriet Taylor, John Stuart Mill represents a transitional point between Classical economics and the more familiar schools of economic thought that would follow.

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2.3 Circular Flow Diagram

Origins of the circular flow diagram can be traced to Francois Quesnay (1694-1774). Quesnay belonged to a group of economists known as the Physiocrats, so named because Quesnay was himself the court physician for Louis XIV in France. As a physician, Quesnay likened economic activity to the functioning of the human body. Money and goods were to the economy what blood was to the body.

The original circular flow diagram was Quesnay's Tableau Economique, drawn for the king in 1758 and revised in 1766. It demonstrated how inputs, revenue and goods were exchanged between farmers, landlords and merchants.

The circular flow diagram appearing in the text traces most directly back to economist Francis Knight and his "wheel of wealth" that he constructed in the 1930s.