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Limited resources to produce goods
Study of how rational people make choices
Rational (economic) Decision Making
Two key building blocks:
1. Opportunity Cost
2. Marginal Analysis
The opportunity cost of an action is what one forgoes (gives up) by not taking the best
1. 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?"
2. Opportunity cost includes time cost as well as money cost. (class examples emphasize this
You choose to attend a concert, which costs $50. What is opp. cost?
To answer: Must identify next best alternative
If your next best alternative is to work for 2 hours and earn $80, opp. cost = $50 + $80 = $130
*The opp. cost of spending $1 is $1 (since you could spend on other goods or services) Example 2
You choose to go to a concert, which cost $50. Your next best alternative is to go for a walk, which
you value at $25.
Opp. cost = $50 + $25 = $75
Q: In 2005, you purchased a bottle of rare wine for $50. In 2008, you could have sold the wine for
$200. Today, you could sell the wine for $75.
If you drink the wine today, and the next best alternative is to sell it, what is the opp. cost?
0 (you already paid for it )
$75 (sold now)
$200 (sold 2008)