You receive $100 as a gift and are deciding how to spend it. You narrow down your choices to A, B, C – each costs exactly $100. Finally you decide to purchase B. What is the opportunity cost of this decision?
A. The value of A and C combined
B. The value of the option you would have chosen if not B
C. $100
D. $300
Answer
B. The value of the option you would have chosen if not B
Explanation
Opportunity cost refers to the value of the next best alternative foregone. In this case, by deciding to purchase option B, you forego the value of C if you had chosen C, and the value of A if you had chosen A. So correct answer to the opportunity cost incurred by this transaction is the value of the option you would have chosen if not B.
Revision
What is the definition of “trade-off”?
- An alternative that we sacrifice when we make a decision
What does the phrase “guns or butter” mean?
- It is a phrase that refers to the trade-offs that nations face when choosing whether to produce more or less military or consumer goods
Do only individuals make decisions that involve trade-offs?
- No, groups and governments also have to make these types of decisions
If we choose to spend more time doing homework, you give up time watching TV or spending time relaxing. What is this an example of?
- A trade-off
How do businesses make trade-off decisions?
- They make a decision on how to use land, labor and capital resources.
What is an example of a trade-off that a business would make?
- When a farmer decides to use the land to plant broccoli and not cauliflower
Do countries make decisions that involve trade-offs?
- Yes, when they decide between “guns or butter” they make this type of decision
Why is the term “guns or butter” used?
- Since resources are limited, the steel used to build tanks cannot be used to make dairy equipment needed to make butter
What is opportunity cost?
- The most desirable alternative given up as the result of a decision
What is an example of an opportunity cost?
- If a family decides to buy a computer, they can’t use the same money to go on trip, their second choice. The trip is the opportunity cost of buying the computer
Is there an opportunity cost associated with every decision that is made?
- Yes, each choice we make has an opportunity cost:
- If you sleep in, your opportunity cost may be the fun activity you will miss
What can help you understand the opportunity cost associated with a decision?
- A decision making grid
Why do we need a decision making grid?
- At times, a decision’s opportunity cost may be unclear or complicated
How do you set up a decision making grid?
- List each alternative on the grid
- List the benefits for each alternative
- List the opportunity cost
- List the benefits that you loose with each decision
Are the opportunity costs and benefits the same for each situation?
- No, with each new situation, the opportunity costs and benefits change
Do we always fact an opportunity cost when making a decision?
- Yes, when we select one alternative, we have to sacrifice at least one alternative and let go of the benefits.
What helps us make a decision?
- By understanding what we are sacrificing by making that decision and whether it is worth it
How do economists describe making a decision?
- Choosing is refusing
What do economists point to when making a decision, in addition to opportunity cost?
- They refer to “thinking at the margin”
What does “thinking at the margin” mean?
- deciding whether to do or use one additional unit of some resource
What makes thinking at the margin effective?
- It provides more options in making a decision. You look at the opportunity cost of each extra unit and compare it to the benefit.
What is an example of thinking at the margin?
- If Karen is deciding to get up 3 hours earlier to study or sleeping in, she can make her decision based on each hour and decide if the benefit is worth it. For example, if gets up one hour earlier, she can get a C, if she gets up 2 hours earlier she can get a B and if she gets up 3 hours earlier she can get an A. She can decide which grade is best and make her sleeping decision based on that benefit.
Which decisions can Thinking at the Margin be helpful for an individual?
- how much money to spend on a car
- how many hours to work
- how much time to spend watching TV
Which decisions can employers make by thinking at the margin?
- Decide how many employees to hire
Which decision can legislators make by thinking at the margin?
- Decide if a government program should include more or less of a particular benefit
Is making a decision by thinking at the margin different than considering opportunity cost?
- No, it isn’t. Decision makers just have to compare the opportunity costs and the benefits, what they will sacrifice and what they will gain.
- Once the opportunity cost outweighs the benefits, then no more units should be added.
When should no more units of something be added when making a decision?
- When the opportunity cost is greater than the benefits.
- In other words, when what they sacrifice is greater than what they gain.
What is the definition for “marginal analysis”?
- Economic analysis of decisions about small, incremental changes to an existing course of action. It asks “Is it worth it”?
What is analyzed in a “marginal analysis”?
- The marginal costs vs. marginal benefits
- is the additional cost of producing one more unit of output worth the additional benefits received from producing the additional unit of output?
- What is the RULE of economics?
- People STOP pursuing an activity when the marginal cost becomes EQUAL to the marginal benefit
- What is meant by “private sector”?
- Economic activity by individuals
What is meant by “public sector”?
- Economic activity by a government
What is “production”?
- making/selling of goods and services that satisfy the consumer’s wants
What are “goods”?
- Items we consume
