The Economic Way of Thinking
The studyof howpeoplemakerational An individualhas a limited budgetand limited time.
choices on the allocation ofscarce A society likewise haslimited resources with which to producegoods.
resourcesto fulfill unlimited wants. This scarcity forcesindividuals,firms, and societies to make choices. Opportunity Cost
Opportunity cost is what one forgoes (gives up) by not taking the next best alternative action.
1. The question "ShouldI do or pursue X?" should instead be replaced by "ShouldI do X or
Y?"where Y is the most highlyvalued alternative.
2. Opportunity cost includes both time and money costs.
*NOTE:opportunity cost is dollar per dollaror $1 forgone = $1 of opportunity cost.
1. You choose to go to a concert for $50. Your next best alternative is to work for 2 hours to earn
Opportunity cost = 50 + 40 = 90.
2. You choose to go to a concert for $50, instead of going on a walk that you personally value at $25.
Opportunity cost = 50 + 25 = 75.
Difficult Examples: Another Example:
1. In 2005 you bought a bottle of rare wine for $50.
In 2008 you had the opportunity to sell it for $200. December 1990, Ontariopredicts first year post-secondary enrolment at 25,000.
Today you can sell it for $75. Spring 1991, the economy enters a deep recession, and unemployment rates rise.
Opportunity cost = 75 if you drink it. September 1991, more than the predicted 25,000 students enrol.
Note: the price you purchased it for and the opportunity to This is because the opportunity cost of attending university is lower, either because
sell it do not matter as they are not the next best the foregone earnings are less, or because there are less available jobs.
alternatives to drinking the wine at the current point in
time. Opportunity cost of attending university if the next best alternative is to work
2. You receive free concert tickets, but then cannot go to
dinner at your favourite restaurant. Tuition/books $8,000
You value the dinner at $100, but it would have cost $75. Tuition/books $8,000
Foregoneearnings $20,000 Foregone earnings $40,000
Opportunity cost = 25, from 100 - 75 = 25.
Opportunity cost $28,000 Opportunity cost $48,000
Measuring Opportunity Cost:
The foregoneearnings are a highly important part of opportunity costs, and if the
opportunity cost is high, the action is consequently lesslikely to be taken.
direct costs Next BestAction Take, for example, how some highschool athletes go on to become professionalsrather
plus dollar amount or value
than go to university.
less Hotdog Stands:
direct costs of NBA
Shouldthis individual operate a hotdog stand?
Revenues (per 8 hour day) $250
Costs (per 8 hour day) $150
But wait, there's missing information:
What isthe opportunity cost of the individual'stime?
1. If one earns $15 per hour, the OC is $120 per day.
2. Because $120 > $100, don't operate the stand.
3. Conversely, if the OC < $100, operate the stand.
Thisis why few medical professionals operate hotdog stands :p
ECO100Y1YPage 2 Marginal Analysis
The Economic Way of Thinking:
Rational Economic Decision Making
Thereare two key building blocks:
The concept of Opportunity Cost MarginalCost
What you forgo or give up by not taking the next best alternative action.
The issue of MarginalAnalysis Additional cost if action is taken.
Undertake an activity if the marginal (additional) benefit exceeds the marginal (additional) cost. MC consists of all the additional
Insights: opportunity costs.
Include all opportunity costs.
Ignore sunk or "fixed" costs - costs which are incurred whether or not the action is taken.
The only relevant costs are those which can be avoided if the action is not taken.
1. Marginalbenefit of attending sports event: You buy a truck from a Should this restaurantstay open for lunch?
$100 (both Jack and Jill) junkyardfor $3000. You
2. Ticket price: $50 plan to spend $2000 to get
Lease: $12000 per month = $400 per day
a. Jack buys one week in advance it running and resell it for Dinner: 150 meals
b. Jill plans to buy on the day of the $6000. If the truck does not
event run, it has a market value Lunch: 25 meals
3. The subway breaks down on the day of the
event, and Jack and Jill both face MarginalRevenue
unexpected costs of $75 for taxis. Unfortunately, the truck 25 meals x $20 = $500
4. Should Jack attend? will cost $5000 to restore.
Should Jill attend? Do you repair the truck? MarginalCosts
Answer: Yes, because the Marginal Chef: 3 hours x $30 = $90
Benefit is 6000 and the
Jack should attend. 2 Waiters: 6 hours x $10 = $60
MB=100 MC=75 MB>MC MarginalCost is 5000. Food: 25 meals x $5 = $125
[the ticket price is a sunk cost] MB > MC, so repair the
Jill should not attend.
MB = 100 MC=75+50=125 MB MC
ECO100Y1YPage 3 Incentive
An event that alters the marginal benefit or marginal cost of an action (and can thus affect whether an action is taken).
Incentives: Unintended Consequences of Public Policy The Optimal Amount of "Care" or Attention to Safety when
1. To help low-paid workers, provinceraises the minimum wage rate to $10.00per hour.
Employers choose to hire fewer workers thus reducing the opportunity of unskilled workers to Provincerequires the use of seatbelts, to reduce injuries.
2. To protect workers, provincerequires firms to make severance payments if plant is shut down. Before legislation, driverschoose degree of safety by
Firms can choose where to locate plants, fewer plants may be