Unit 1:�Basic Economic Concepts
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Topic 1.5-
Cost-Benefit Analysis
Is it possible to…
YES! But the costs outweigh the benefits.
It is not enough that an outcome has benefits. Those benefits must outweigh the costs.
What types of costs should you include when making decisions?
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1. You want to visit your friend for a week. You will return Sunday night.
2. You work every weekday earning $100 per day.
3. You have three flights to choose from:
Thursday Night Flight = $275
Friday Early Morning Flight = $300
Friday Night Flight = $325
Given the following assumptions, make a rational choice in your own self-interest (hold everything else constant)…
Which flight should you choose? Why?
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Trade-offs vs. Opportunity Cost
ALL decisions involve trade-offs.
Opportunity cost- most desirable alternative given up when you make a choice.
Trade-offs - ALL the alternatives that we give up when we make a choice.
(Instead of going to the movies you could go out to eat or visit your grandma or play video games)
What are trade-offs of deciding to go to college?
What is the opportunity cost of going to college?
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Explicit Costs v. Implicit Costs
Economists examine both EXPLICIT COSTS and IMPLICIT COSTS
Explicit costs are the traditional out of pocket costs associated with making a decision.
Examples: Price of a movie ticket.
Implicit costs are the opportunity costs of making a decision,
Examples: The forgone time or forgone wage you could have earned when you go to the movies.
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2008 Audit Exam
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What decisions did you make yesterday?
To snooze or not to snooze?
Breakfast at home or fast food or none at all?
Buy or bring a lunch?
Who to sit with at lunch?
Study or hang out with friends after school?
Go to bed on time or watch Netflix?
Why do you have to choose to do some things and not others?
All of your choices involve a cost of some kind, even if it is not money...what are the costs?
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In the News: Professional Line Sitters
When does it make sense to pay someone to wait in line for you?
Economics of College
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Guns and Butter
"Every gun that is made, every warship launched, every rocket fired signifies, in the final sense, a theft from those who hunger and are not fed, those who are cold and are not clothed. This world in arms is not spending money alone. It is spending the sweat of its laborers, the genius of its scientists, the hopes of its children.”
“The cost of one modern heavy bomber is this: a modern brick school in more than 30 cities. It is two electric power plants, each serving a town of 60,000 population. It is two fine, fully equipped hospitals. It is some fifty miles of concrete pavement.”
“We pay for a single fighter plane with a half million bushels of wheat. We pay for a single destroyer with new homes that could have housed more than 8,000 people.”
-Dwight Eisenhower
Speaking against the military build up of the cold war
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The USS Dwight Eisenhower
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Launched in 1975 and cost $679 million ($4.5 billion in 2007 dollars)
Benefits and costs on a graph
Assume you are buying slices of pizza at a sporting event…
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Quantity of Pizza
Benefits and Costs
Marginal Benefit (MB)
$10
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MB/MC
Each slice of pizza gives you less and less additional benefit (utility)
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Quantity of Pizza
Benefits and Costs
Marginal Cost (MC)
MB/MC
$10
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Each additional slice costs more and more since you miss more and more of the game
1 2 3 4 5 6 7 8 9 10
Quantity of Pizza
Benefits and Costs
MB
MC
MB/MC
$10
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5
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1 2 3 4 5 6 7 8 9 10
Quantity of Pizza
MB/MC
MB
MC
Benefits and Costs
$10
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Why is 5 slices the optimal amount?
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Quantity of Pizza
MB
MC
Not
Enough
(MB>MC)
MB/MC
Benefits and Costs
$10
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1 2 3 4 5 6 7 8 9 10
Quantity of Pizza
MB
MC
Too Much
(MC>MB)
MB/MC
Benefits and Costs
$10
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1
1 2 3 4 5 6 7 8 9 10
Quantity of Pizza
MB/MC
MB
MC
Benefits and Costs
$10
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MB = MC