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
2, If opportunity cost increases from $15,000(sept.2012) to $45,000(sept.2013), individual C will choose
NOT to attend university
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
Direct Costs( each dollar spent has opportunity cost of one dollar)
Next Best Alternative
Dollar amount or value assigned by you Less
Rational Decision Making
Undertake activity if marginal(additional) benefit exceeds marginal(additional)cost.
1. Include all opportunity costs.
2. Ignore sunk costs
Sunk Costs( “Fixed” Costs)
Costs which are incurred whether or not action is taken
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?
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,