# Topic 1 - The Economic Way of Thinking Opportunity Cost

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16 Oct 2011
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ECO100Y1-Pesando-Notes edited by Eva Wu
Topic 1 - The Economic Way of Thinking
(Week One Sep 13th Sep 17th)
Sep 13th Scarcity & Opportunity Cost
Scarcity: Individual: limited budget; limited time
Society: limited resources to produce goods
Economics: the study of how rational people make choices;
the study of how society managers its scarce resources;
Scarcity leads to Choices leads to Economics (the study of making choices).
1. Opportunity Cost:
what one forgoes by not taking the best next alternative;
whatever must be given up to obtain some item;
Insights:
a. The question “Should I do X” should be replaced by
“Should I do X or Y where Y is the most highly valued alternative to X”
b. Includes “Time Cost” as well as money cost
e.g.1. What is the OC of attending University for one year (\$8,000) if the next best alternative is working
full-time at \$20,000/yr?
Opportunity Cost = Tuitions/Books + Forgone Earnings = \$8000+\$20,000
The Opportunity Cost of spending \$1 is \$1 (you could use the same dollar to buy other goods or services);
e.g.2 What is the OC of attending a 2-hr movie (ticket \$12) if:
a). the next best alternative is working a P/T job at \$10/hr
OC=Ticket Price + Forgone Earnings = \$12 + \$20 = \$32;
b). the next best alternative is going for a walk
OC=Ticket Price + the Satisfaction from the walk (no monetary value)
(but the satisfaction from the walk apparently exceeds \$20.00, by implication);
e.g.3 someone operates a hotdog stand with:
a. Revenue from an 8-hr day: 100 hotdogs x \$2.5/hotdog = \$250;
b. Cost of an 8-hr day: Rent-\$75; Profit = \$100
buns, hotdogs = \$25; Total Cost = \$100;
NOW should one continues operating the hotdog stand if:
a). The next best alternative is working at \$15/hr?
No, \$15 X 8 = \$120 greater than \$100;
b). The next best alternative is working at \$10/hr?
Yes, \$10 X 8 = \$80 less than \$100.
c).Why do few medical doctors operate hot dog stands?
Since medical doctors are the highest-earning professions in Canada, the opportunity cost of their time is
too high for them operate hotdog stands.
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ECO100Y1-Pesando-Notes edited by Eva Wu
Application 1: Enrollment Rate
In Dec 1990, an Ontario University predicts its first year enrollment to be 25,000;
In spring 1991, the economy enters a deep recession, and employment drops greatly;
In Sep 1991, What is the actual enrollment going to be? Greater or Less than 25,000?
The OC of attending university (e.g.1) is Tuition/books + Forgone Earnings.
In this case, the unemployment increased greatly, prospective students are much less likely to get a job as
they used to expect. Their Forgone earning decreases greatly. The OC as a whole decreases greatly.
Therefore, there is a huge increase in the actual enrollment.
e.g.4
a). What is the OC of going to a free concert (2-hr) if the next best alternative is dinner at your favorite
restaurant? (the dinner is valued by you at \$100; dinner cost \$75;)
0; \$25; \$100; \$175
You receive a satisfaction from the dinner which is valued by you at \$100. For the dinner you spend \$75.
Therefore if you do not go to the dinner, you are giving up \$25 in value (\$100-\$75). And the concert is for
free, so there is no direct cost. Therefore the OC is \$25.
b). What if the meal is for free?
The OC increases to \$100 (your satisfaction for the dinner is \$100 with no cost;)
Always in mind: “WHAT DID YOU GIVE UP?”
e.g.5.
a). You decided to go to a concert which you value at \$400. The concert costs you \$200. Your next best
choice is having dinner at your favorite restaurant which you value at \$150 and costs you \$100. What is
the OC of going to the concert?
OC= \$200+(\$150-\$100) = \$250
b).What if the value of the Concert goes up?
The OC is unchanged.
The value of the concert DOES NOT impact OC, but rather impact your decision of going to the concert. If
the value you assign to the concert is greater than the cost, you make the decision of going to the concert,
and vice versa. Once the decision is made, the value of the concert no longer impacts on the OC; only the
direct cost of the concert, the value and cost of your next best choice will impact on the OC, because
THAT’S WHAT YOU GIVE UP FOR the concert.
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