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ECO101H1 (575)
Lecture

Econ Lecture 2.docx

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Department
Economics
Course
ECO101H1
Professor
James Pesando
Semester
Fall

Description
Review: Opportunity cost of taking an action: what you forgo (give up) by not taking the next best alternative If the opportunity cost of taking an action is high, you may choose not to take the action Example 1 You decide to go out for dinner, which costs $100. You value the dinner at $200. Your next best alternative is to attend a concert, which you value at $75. The cost of a ticket to the concert is $50 What is the opportunity cost of going out to dinner? a) $25 b) $50 c) $75 d) $125 e) none of the above What is the opportunity cost if you value the dinner at $400? a) $25 b) $50 c) $75 d) $125 e) none of the above Answer Action Taken $100 (Direct Cost) Next Best Alternative $75 monetary value Less ($50) Direct Cost $125 Observation The value you assign to the dinner does not affect its opportunity cost. Rational Decision Making Undertake activity if marginal (additional) benefit exceeds marginal (additional) cost 1 Insights 1) Include all opportunity costs 2) Ignore sunk costs Sunk Costs (“Fixed” Costs) Definition: Costs which are incurred whether or not the action is taken. Insight Only relevant costs are those which can be avoided if action is not taken. Example 2 Restaurant: Should it stay open for lunch? Lease Payment: $12,000 per month  $400 per day Dinner: 150 meals Lunch: 25 meals Additional (Marginal) Revenue 25 meals at $20 = $500 Additional (Marginal) Costs Chef: 3 hours at $30 = $90 Waiters (2): 6 hours at $10 = $60 Food: 25 meals at $5 = $125 ------- $275 Conclusion: 1) $500 - $275 = $225  profitable to stay open 2) 2) fixed (sunk) cost of lease is not relevant Restaurant: Should It stay open for lunch? Lease Payment: $12,000 per month  $400 per day Dinner: 150 meals Lunch: 8 meals Additional (Marginal) Revenue 8 meals at $20 = $160 Additional (Marginal) Costs Chef: 3 hours at $30 = $90 Waiters (2): 6 hours at $10 = $60 Food: 8 meals at $5 = $40 ------- $190 2 Conclusion: 1) $160 - $190 = $-30  not profitable to stay open 2) 2) fixed (sunk) cost of lease is not relevant Example (Rational Decision Making) 1) You buy a $30 concert ticket, but lose t
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