Understanding the Trade Market: Opportunity Cost

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Published: February 18, 2014
Understanding the Trade Market

Everything has a cost. I’ve said it before, and I’ll say it many-a-time until they run me off this site.

Even if a thing is free from a financial perspective, it has a cost from an economic perspective.

The difference here is crucial. The financial perspective is simply about money. Straight up. Plain. Simple. Vanilla. If I don’t give you money, or something worth money, then it is free from a financial perspective. The economic perspective, which is the focus of this series, is about goods, services, and choices. Financial considerations play a role, but they are not the focus. It is from this perspective that a free lunch in the phrase “There is no such thing as a free lunch” is actually not free.

This logic is also the basis of “Time is money.” While time is clearly not money, it is a resource that can be used in the generation of money.

Let’s walk through a lunch to find the cost. While we are at it, we’ll find the benefit, too. I walk up to a restaurant, find myself a nice table, and sit down. I order the shrimp and grits (long time readers saw this coming). I wolf down the delicious deliciousness, then the server comes over and says, “It’s on the house, boo.” So, I have gotten my lunch (and the delicious deliciousness) but paid no money. I claim that this is not free in that there is an economic cost despite there being no financial one.

I’ll let you think about it before I tell you what the cost is.

No, it’s not the cost to restaurant or society. (That’s not my problem, at least not directly)

No, it’s not the cost to my health. (That may be a cost, but not if I picked a carrot instead of shrimp and grits)

No, it’s not allowing me to live and subject you my ramblings. (That’s just a reminder that life is pain)

Got it? Give up?

The cost is: The thing I would have ordered had I not ordered the shrimp and grits. In this case, it was the shrimp etouffee.

More generally, when you select good or service X that you prefer (perhaps in a constrained sense), the economic cost is the next preference (in the same constrained sense, if applicable). In other words, choosing one thing prevents the choice of another, and that is the cost. That is the lack of freeness of the proverbial lunch.

It is important to note that the cost is a real opportunity. Etouffee is the correct opportunity cost in my example since I’m going to buy lunch and I’m staring at the menu. A poached brontosaurus egg is not an opportunity cost for anyone and can never be. While imaginable, the fact that brontosauri never existed (they were, sadly, an “oops” by the sciencey types), even if they had, there are no eggs around and no John Beshrock to poach those suckers for profit. The opportunity has to be real.

Opportunity Cost

The opportunity cost is the opportunity lost. It rhymes, so it must be true, right?

Opportunity cost is not intrinsically financial, and it is often very difficult to evaluate. For example, in the given lunch example, the choice was between a number of dishes. I chose one, and the next best option was the opportunity cost. In reality, however, the situation is more complex. What if I can get a cheaper lunch that I enjoy (Smoothie!), pocket that cash, do that for a couple of days, then head over to Root for the Korean short ribs. Did my shrimp and grits cost me etouffee or the ribs? How many shrimp and grits dishes must I eat before it costs me the ribs? If my dining companion dislikes Root, does the money or the choice to join them for dinner cost me the ribs?

Did my losing money on the slot machines cost me the chance to lose at blackjack or did it cost me rent money?

Did going to this bar instead of that bar save the cover charge or cost me the chance to meet RZA?

As you can see, opportunity cost is not limited to comparisons among similar goods and services. Opportunity cost can reach across many different markets and choices, and it can vary depending on the overall scope of evaluation. It is a very ticklish subject.

Opportunity Cost in the NBA Trade Market

When it comes to NBA trades, fans often discuss opportunity cost without ever using the phrase.

“We could have gotten more for him.”

When it comes to the NBA trade market, opportunity cost can be considered to be the best trade not made. In most cases, the best deal not taken is not known to those not involved in the deal. As such, the opportunity cost is often speculative and highly subjective.

Keep in mind: the opportunity cost is not LeBron James. He is not an option in nearly all cases, and he his services have yet to be turned away.

It may be temping to say the cost of a trade is the value of the assets leaving, but this is incorrect.

For example, consider the following Pelicans’ trade: Nerlens Noel and a top-5-protected first round 2014 draft pick for Jrue Holiday and the 42nd pick in the 2013 draft (Pierre Jackson). A common tendency is to say the benefit to the Pelicans is Jrue Holiday and Pierre Jackson’s rights, while the cost is Nerlens Noel and the pick. This is more of the financial notion of cost . . . it’s just how the deal was done . . . it’s the equilibrium that was reached. (Also, serious critics of the deal who fail to account for Jackson’s value display something between ignorance and bias through that action . . . leaving Jackson off in casual discussion is understandable, but to denigrate the deal apart while ignoring a more and more highly touted asset is bad form.)

Evaluating the trade is done by comparing this deal to the best trade not made, or perhaps not trading. In the case of not trading, the comparison is to the Pelicans roster with their 2013 draft selection and the rights to their 2014 draft pick and whatever position it would have fallen into. Understanding how the team would have proceeded on and after draft night is difficult and based on speculation (if reasoned), and therein lies the difficulty in assessing opportunity cost.

Therein lies the root of so much discussion.

It should also be noted that this perspective is how it is possible for both teams involved in a (2 team) trade to “win” the trade. In each case, the team “wins” the trade if they better themselves more than another deal would have. Too often, a deal is only seen as a “win” if the other participant ends up “hurt” by the trade. While this can happen, that is poor analysis.

A good example of a win-win trade is the so-called Kwame Brown trade, dubbed such to make it seem like a bad idea (in my opinion). The core of the deal was the expiring Kwame Brown contract (and Kwame), two first round picks, and the draft rights to Marc Gasol going to the Grizzlies while Pau Gasol went to the Lakers. The Lakers immediately improved, and Pau Gasol helped the team win two titles. The cap space from Kwame Brown’s deal coming of the Memphis books (in a way Pau Gasol’s deal would not have), Marc Gasol, and those picks helped Memphis turn themselves into contenders in a few years. Both teams seem to have benefited from the deal, which is exactly what both teams were going for. The smaller pieces of the deal have an importance dwarfed by that of those mentioned.

Lagniappe: One of those Lakers picks the Grizzlies used . . . it was used to pick Greivis Vasquez.

Opportunity Lost, Opportunity Regained

Discussion of the Marc Gasol trade (yeah, I said it) brings up a very important point.

It is very important.

Muy importante.

Are you ready?

When an action is undertaken, the opportunity to take another action with those resources (time, money, mana, whatever) is lost, as mentioned above. The reverse is also true. If resources to make a choice can be acquired, then the opportunity for opportunity is regained. In the Marc Gasol deal, the Grizzles got a player with 2 fewer years on his contract that Pau, and the cap space was available the summer following the trade. With Pau on the Memphis books, they would have missed out on the chance to make other moves, good or bad.

Since Kwame Brown was not a particularly helpful player at the time, the cap space Brown vacated was seen as an asset. However, when Dwight Howard left the Lakers in free agency, the team was criticized for letting Howard leave “for nothing.” While Howard may be more valuable than the cap space he occupied (or would have), this is not the proper comparison. The proper comparison is the Lakers’ cap space compared to the contracts they may have received in return for Howard in a sign-and-trade. If they valued their 2013-2014 or 2014-2015 cap space quite highly, then perhaps the Howard non-trade was their best option. Time will tell.

Keep in mind that the comparison is not to Dwight: He did not want to sign, so he was not an option. Neither was LeBron James.

Circling around to a situation in New Orleans, the Chris Paul trade netted 4 assets for New Orleans: Al-Farouq Aminu, Eric Gordon, Chris Kaman, and a draft pick (Austin Rivers). The trade also likely raised the value of their own draft pick, as it was used to acquire Anthony Davis. In this deal, Chris Kaman represented cap space for the following off-season, and that cap space was used to make an offer to Ryan Anderson (which later became a sign-and-trade). That cap space was also used to absorb Brad Miller’s deal. Since he was traded into cap space, he could aggregated with a minimum contract, this allowed Phoenix to send Robin Lopez and Hakim Warrick to New Orleans. Warrick was traded for dead money, but Lopez was part of the deal to bring Tyreke Evans to New Orleans.

Fans were vehement in their desire to see Kaman traded while he was an expiring contract, but the contract actually expiring created cap space that became (with some help) players much more valuable that Kaman could have fetched in trade.

By comparison, Chris Paul leaving before his option year (which was the claim made at the time), would have presumable left New Orleans with fewer assets in trade or perhaps cap space alone, if more cap space. What Dell could have done with that cap space is unclear, but it is to these possibilities the 4 assets must be compared, not Chris Paul himself: he was not an option, at least according to him at the time.

Opportunity cost is immensely complicated in general. In the twisted market of the NBA with its various currencies of talent, salary, draft picks, draft rights, actual money, and more, it is mind-bending at times. Just keep in mind that a trade must be compared to another transaction . . . or no transaction at all . . . to truly judge it. Sometimes that second transaction is obvious, while it is strewn across time in others.

For all the pain, opportunity cost may actually be what brings those that debate NBA transaction the most pleasure . . . in the form of debate itself.

4 comments
thouse
thouse

Nice read. Thanks.

Same thing with questioning the Holiday trade. I get why they did it (more than just on court reasons). I liked it at the time. I still like it now. But I do think it's fair to wonder what if. Obviously it is just barroom semantics, but that's one reason why we meet on places like this, right?

wilthomas178
wilthomas178

I guess i've turned the corner on this trade season..or maybe i'm just resigned to the fact that a major move cannot or will not be made..

so if a wilson chandler for steamer, aminu and rivers goes through..so be it..

in the offseason go after a healthy Okafor..and  then go from there..

starter..             bench

1.oakfor             1.  withey

2 davis               2. anderson

3. chandler      3.  miller

4. gordon         4.  evans

5. holiday        5.   p. jackson??


might can get back into the draft by trading roberts and/or morrow..who knows

Caffeinedisaster
Caffeinedisaster

Just think:


If Chris Paul had left in his option year instead of the year before, we would be subject to a draft of:

MCW

Oladipo

Bennett

Porter

Noel


Thanks CP3/David stern for giving us Anthony Davis!

Trackbacks

  1. […] Understanding the Trade Market: Opportunity Cost It is important to note that the cost is a real opportunity. Etouffee is the correct opportunity cost in my example since I'm going to buy lunch and I'm staring at the menu. A poached brontosaurus egg is not an opportunity cost for anyone and can never be. Read more on Bourbon Street Shots […]

  2. […] Understanding the Trade Market: Opportunity Cost Everything has a cost. I've said it before, and I'll say it many-a-time until they run me off this site. Even if a thing is free from a financial perspective, it has a cost from an economic perspective. The difference here is crucial. The financial … Read more on Bourbon Street Shots […]