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University of Toronto St. George

Lec2. The Economic Way of Thinking 1. The Economic Problem: Scarcity requires Choice 2. Economic Decision-Making 2.1 Opportunity Cost What one forgoes by not taking the best alternative action 2.2 Marginal Analysis Compare Additional Benefits with Additional Costs Ignore Sunk Costs Opportunity cost of taking an action: what you forgo by not taking the next best alternative Answer to the question in Lec1. :$200+($150-$100)=$250 Opportunity cost does not depend on the value to you of the action taken. 1, Benefit of attending university for one year Individual A. $275,000 B. $150,000 C. $30,000 2, If opportunity cost increases from $15,000(sept.2012) to $45,000(sept.2013), individual C will choose NOT to attend university Onservations 1, Opportunity cost is the SAME for A,B, and C 2, Because of individuals like C, enrollment declined in spt. 2013 Measuring Opportunity Cost Action Taken Direct Costs( each dollar spent has opportunity cost of one dollar) plus Next Best Alternative Dollar amount or value assigned by you Less Direct Costs Rational Decision Making Undertake activity if marginal(additional) benefit exceeds marginal(additional)cost. Insights 1. Include all opportunity costs. 2. Ignore sunk costs Sunk Costs( “Fixed” Costs) Definition Costs which are incurred whether or not action is taken Insight Only relevant costs are those which can be avoided if action is not taken 1.Marginal benefit of attending sports event: $100 (both Jack and Jill) 2. Ticket Price: $50 1)Jack buys one week in advance 2)Jill plans to buy on day of event 3. Subway breaks down on the day of event, and Jack and Hill both face unexpected cost: $75 for taxis 4. Should Jack attend event? Should Jill attend event? Answer Jack should attend: MB=100 MC=75 MB>MC (ticket price is a sunk cost) Jill should not attend: MB=100 MC=75+50=125 MBMC, so you repair the truck. Profit: $6,000- $8,000=($2,000) If do not repair truck, profit= $0- $3,000=($3,
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