The Economic Way of Thinking User:pesando Password:windsor The Economic Problem: Scarcity requires Choices -individual budget -limited

time -Society- limited resources to produce good choices Economic Decision - Making Economics-the study of how rationally people make choices Opportunity Cost -the opportunity cost of an action is what forgoes (gives up) by not taking the best alternative -Insights-the question should I do X? should b replaced by should I do X or Y? E.g. The opportunity cost of attending university for a year 1. If the next best alternative is full-time work at $20000/year, the opportunity cost is: Tuition/books $8000 Forgoing earnings $20000 $28000 2. If the next best alternative is full time work at $40000/year, the opportunity cost is: Tuition/books $8000 Forgoing earnings $40000 $48000 *If room and board is $7000, do we include that in the OC? NO E.g. The opportunity cost of attending a movie 1. If the next best alternative is working part time at $10/hr, the opportunity cost is: Ticket price $12 Forgoing earnings $20 (2 hours) $32 2. If the next best alternative is going for a walk, the opportunity cost is: Ticket price $12 Satisfaction f walk monetary value exceeds $20 by implication *Not every decision we make has a distinctive cost E.g. Receive free concert ticket (2hours) 1. Next best alternative is dinner at favourite restaurant which you value at $100 (2hr), cost of meal is $75. Opportunity cost is: 0? 25? 100? 175? Monetary value $100 Direct cost -$75 $25 Measuring Opportunity cost Action Taken Direct Costs (each dollar spent has an opportunity cost of one dollar)

Next best Alternative Dollar amount or value assigned by you *(minus direct costs)

*Opportunity Cost does NOT depend on value to you of ACTION TAKEN (value to you is relevant when you are choosing among alternative actions) E.g. Action taken- dinner which costs $100 NBA- work 2 hours and earn $50 1. OC: $100+$50=$150 2. Does OC change if: Value to you of dinner is $250? No. $500? No. $75? No. (You would never have gone to the restaurant because it costs $100) The monetary value of action is irrelevant Applications E.g. Should this individual operate a hot dog stand? 1. Revenues (per 8 hour day) 100 hot dogs @ $2.50 = $250 2. Direct costs (per 8 hour day) Rent of stand -$75 Hot dog buns -$75 -$150 3. Difference is $100 (250-150) *Missing info -opportunity cost of individuals time 1. If person could earn $15 per hour, opportunity cost is $120 for an 8 hour day 2. Since $120 exceeds $100, he should NOT operate stand 3. What if the opportunity cost is $10 per hour? Insight High opportunity costs less likely to take action E.g. Plan to attend university rather than work (next best alternative) Obtain high paying job opportunity cost is a high result Summer jobs for high school graduates (equally good students) A. $20000 per year B. $40000 per year If summer job was made permanent, who is more likely to attend university? Student A December 1990 Ontario Universities predict first year enrolment: 25000 Spring 1991 Economy enters deep depression Employment drops unemployment rises Sept 1991 Is actual enrolment likely to be more than 25000 or less than 25000? Answer: More than 25000 because employment cost is lower and opportunity cost is higher

Marginal Analysis -create reasonable and logical thinking in an economic context Rational Decision Making -Undertake activity if Marginal (additional) benefit exceeds MARGINAL (additional) cost Insights 1. Include all relevant opportunity costs 2. Ignore sunk costs Sunk Costs (fixed cost) 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 E.g. Restaurant: Should it stay open for lunch Lease Payment: $12000 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. Fixed (sunk) cost of lease is NOT relevant OR Lease Payment: $12000 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 a $10 = $60 Food 8 meals at $5 =$40 $190 Conclusion: 1. $160-$190= $-30 (NOT profitable to stay open) 2. Fixed (sunk) cost of lease is NOT relevant

E.g. Marginal benefit of attending sporting event: $100 (both Jack and Jill) Ticket Price: 50$ 1. Jack buys one week in advance 2. Jill plans to buy on day of event Subway breaks down on day of event, and Jack and Jill both face an unexpected cost: $75 for taxis Should Jack attend event? Should Jill attend event?

Answer: Jack should attend: MB= 100, MC= 75 MB is greater than MC (ticket price is sunk cost) Jill should not attend MB= 100, MC=75$+50$=125 MB is less than MC Thinking like an economist You buy a concert ticket in advance and pay a reduced price of 50$. Unfortunately, when you arrive at the concert, you discover that you lost the ticket. As planned, you took a taxi to the concert for $20. The cost of the concert ticket at the door is $65. If you have the funds, should you buy a new ticket? Answer: Buy new ticket Marginal Benefit: $70 (at least) Marginal Cost: $65 Note: marginal benefit is at least $70 since you were willing to pay at least $50 for the original ticket price plus $20 for the taxi. BUT...Are taxi ($20) and ticket ($50) sunk costs? YES Insight -Taxi and ticket provide info as to marginal benefit -Marginal cost is $65 (does NOT depend on cost of taxi or reduced ticket price) *Compare Additional Benefits with Additional Costs *Ignore Sunk Costs

People Respond to Incentives Incentive An action which alters marginal benefit or marginal cost of an action (and can thus affect whether an action is taken) Incentives: Unintended Consequences of Public Policy Example 1: To help low-paid workers, province raises the minimum wage rate to $10.00 per hour Response: employers CHOOSE to hire fewer workers thus reducing the opportunity of unskilled workers to gain experience Example 2: To protect workers, province requires firms to make large severance payments if plan is shut down. Response: Firms can choose where to locate plants, and fewer plants may be opened (thus reducing job opportunities) Example 3: Province requires use of seatbelts, to reduce injuries. Response: Before legislation, drivers choose degree of care by weighing marginal benefits and marginal costs Marginal benefits (reduced accidents, injuries) Marginal costs (drive slower, pay more attention) -With legislation, marginal benefit of care DECLINES (less likely to be injured, if accident) -Drivers CHOOSE to exercise LESS care Evidence (after mandatory seatbelt legislation): Number of serious of injuries FALLS, number of accidents RISES