Opportunity Costs

Because resources are scarce, people must make choices. A choice is a comparison of alternatives. For example, suppose I had a choice of having Kix, Cheerios, or Lucky Charms for breakfast, and I decided to eat the Lucky Charms. When I chose to eat the Lucky Charms I was simultaneously choosing not to eat Cheerios and not to eat Kix. I gave up the chance to eat the Cheerios or the Kix. What I gave up has a value. This value is called the opportunity cost. Every choice has an opportunity cost. Opportunity cost is the value of the next best alternative. Since I chose the Lucky Charms, my opportunity cost is the Cheerios or the Kix, whichever I most prefer. For an accountant, the cost of an activity is the out-of-pocket expenses, all of the money paid to undertake the activity. For an economist, the cost of an activity is everything given up for it, including opportunity costs. For example, what are the total costs of a college education? tuition books beer costs transportation $44,000 3,200 4,800 4,800

opportunity costs 56,000 total costs $112,800

Instead of attending college you could be doing something else such as working or backpacking across Europe. That something has a value to you; the value of whatever you would have done if you had not attended college is the opportunity cost of going to college. Let's say you would have found a job making sandwiches at Sheetz and would have made $14,000 a year. Then, your opportunity cost of attending college would be the wages you could have earned instead.

Marginal Costs and Marginal Benefits

Most decisions are not of the all or nothing variety. Most decisions involve choosing a little more or a little less of something. Rational decision making involves comparing the costs and benefits of that incremental change. Loosely put, the additional costs of undertaking some activity are called the marginal costs. The additional benefits of engaging in that activity are called the marginal benefits. If the marginal benefits are greater than the marginal costs, do it; otherwise, do not. Should you have come to class today? Let's compare the marginal costs and benefits. marginal costs gas, other car expenses paper & ink used $2.00 0.25

opportunity costs (sleeping) 1.00 breakfast total marginal costs 2.00 $5.25

marginal benefits knowledge $0.50

higher lifetime income due to better economics grade earned because you learned about opportunity costs 0.25 in class today were able to socialize with other students total marginal benefits 2.00 $2.75

So, since the marginal costs of attending class today are greater than the marginal benefits, rational behavior dictates that you should not have come to class today.

But, many of you did attend class today. There are two possible explanations. One, you've all behaved irrationally. You came to class knowing that the marginal benefits were smaller than the marginal costs. However, it is not a good idea to assume that so many people have behaved irrationally. So, second, we have incorrectly measured the costs and benefits. marginal costs gas, other car expenses paper & ink used $2.00 0.25

opportunity costs (sleeping) 1.00 breakfast total marginal costs 2.00 $5.25

marginal benefits knowledge $0.50

higher lifetime income due to better economics grade earned because you learned about opportunity costs 0.25 in class today were able to socialize with other students spent 50 minutes with me total marginal benefits 2.00 2.51 $5.26