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Lecture 2

ECON 101 Lecture 2: Opportunity Cost and Marginal Benefit
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Department
Economics
Course Code
ECON 101
Professor
Marina Adshade

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Jan. 09th, 2015
ECON 101 - Lecture #2 - Opportunity Cost and Marginal Benefit
Marginal Benefit
Rational people only make choices when the benefit exceeds the cost
We apply the cost-benefit rule, we need a single metric that can be used to measure
both costs and benefits
That metric is money
Economists usually try to measure all the costs and benefits of a particular course of
action in monetary terms, so
B(x) is the benefit of activity x measured in dollars
C(x) is the cost of activity x measured in dollars
Example 1
How much are you willing to pay for 30 minutes of reduction in commute?
○ $0
More than $0 but less than $40
More than $40 but less than $100
More than $100 but less than $200
More than $200
To measure the value of the reduction of 30 minutes in commute, calculate the average
of each choice: choice a is $0, choice b $20, choice c $70, choice d is $150, and choice
e is $200
Multiply the average by the number of people who chose it
Add the results of all five choices together, divide the sum by the total number of
people
Purpose of the example: showing that there is always a way to quantify an action
Opportunity Cost
The opportunity cost of an action is the value of the next best option that could have
been pursued with the available resources
Remark: Opportunity cost always refers to an action
For example, it is correct to ask” What is the opportunity cost of buying a book?”,
but incorrect to ask “What is the opportunity cost of a book?”
Opportunity cost is one of the most useful concepts in economics
Important: Calculate the net benefit of the next best choice (not just the benefit!)
Identifying and measuring opportunity costs is sometimes difficult, but ignoring them
often leads to incorrect conclusions and poor decisions
Example 2
Imagine that you currently subscribe to The Economist magazine, paying $120 annually.
Furthermore, imagine that the most would be willing to pay for the annual subscription is
$250. If magazine were to close down, how much worse off would you be? (You are at
the beginning of a new year, and you have not paid the $120 yet.)

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Jan. 09th, 2015 ECON 101 - Lecture #2 - Opportunity Cost and Marginal Benefit Marginal Benefit ● Rational people only make choices when the benefit exceeds the cost ● We apply the cost-benefit rule, we need a single metric that can be used to measure both costs and benefits ○ That metric is money ● Economists usually try to measure all the costs and benefits of a particular course of action in monetary terms, so ○ B(x) is the benefit of activity x measured in dollars ○ C(x) is the cost of activity x measured in dollars Example 1 ● How much are you willing to pay for 30 minutes of reduction in commute? ○ $0 ○ More than $0 but less than $40 ○ More than $40 but less than $100 ○ More than $100 but less than $200 ○ More than $200 ● To measure the value of the reduction of 30 minutes in commute, calculate the average of each choice: choice a is $0, choice b $20, choice c $70, choice d is $150, and choice e is $200 ○ Multiply the average by the number of people who chose it ○ Add the results of all five choices together, divide the sum by the total number of people ● Purpose of the example: showing that there is always a way to quantify an action Opportunity Cost ● The opportunity cost of an action is the value of the next best option that could have been pursued with the available resources ● Remark: Opportunity cost always refers to an action ○ For example, it is correct to ask” What is the opportunity cost of buying a book?”, but incorrect to ask “What is the opportunity cost of a book?” ● Opportunity cost is one of the most useful concepts in economics ○ Important: Calculate the net benefit of the next best choice (not just the benefit!) ● Identifying and measuring opportunity costs is sometimes difficult, but ignoring them often leads to incorrect conclusions and poor decisions Example 2 ● Imagine that you currently subscribe to The Economist magazine, paying $120 annually. Furthermore, imagine that the most would be willing to pay for the annual subscription is $250. If magazine were to close down, how much worse off would you be? (You are at the beginning of a new year, and you have not paid the $120 yet.) Jan. 09th, 2015 ● How much you are worse off = the net benefit you have lost (Important: not just benefit, but net benefit, or how much you would have gained if the magazine did not close down) ○ You value the magazine at $250, but only pay $120, thus the net benefit is $130 ● Answer: you are the equivalent of $130 worse off Example 3 ● Russell spends an hour studying instead of playing tennis. What is the opportunity cost to him of studying? ● Opportunity would be the benefit he would have gained if he played tennis ● Answer: The enjoyment and exercise he would have received had he played tennis Example 4 ● You have a free ticket to Adele’s concert. You cannot sell the ticket. You are willing to pay $200 to see Adele. Hedley is playing on the same night. The ticket is $80, and you are wil
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