OPPORTUNITY COST: the value of the NEXT BEST ALTERNATIVE, or what you give up by choosing one

alternative over another

In life, we are forced to make CHOICES. For every decision you

make, you are giving something up. This is called a TRADE-OFF. When we assign a value to this, we call it

OPPORTUNITY COST.

WHAT IS COST BENEFIT ANALYSIS?

A process of examining the advantages (benefits) and disadvantages (costs) of each

available alternative in arriving at a decision.

WHY USE COST BENEFIT ANALYSIS?

IT IS ONE OF THE MOST USEFUL TOOLS FOR INDIVIDUALS, BUSINESSES, AND

GOVERNMENTS WHEN THEY NEED TO EVALUATE THE RELATIVE WORTH OF

ECONOMIC CHOICES.

Benefits Costs

Buy an old car for $2,500.

Buy a new car using the $2,500 as a down payment.

You have $2,500 to purchase a car. Will you buy an old car or use the money as a down payment on a new car? Fill in the decision-making

grid below.What is your decision?

MARGINAL COST:

MARGINAL BENEFIT:

THE COST OF USING ONE MORE UNIT OF A GOOD OR SERVICE

THE BENEFIT OR SATISFACTION OF USING ONE MORE UNIT OF A GOOD OR SERVICE

LET’S TAKE A LOOK…

Benefit in time

Benefit in wages

Opportunity cost: Time

Opportunity cost:

Wages

1 hour

2 hours

3 hours

You have three hours to do with what you like. You need money, so you decide you are going to work, but don’t want to work the whole three hours. You cannot decide how to “maximize your utility” with your time. So, you use the grid below:

You still have 2 hours of free time.

You still have 1 hour of free time.

You have no free time.

You have $7.

You have $14.

You have $21.

You are giving up 1

hour of free time.

You are giving up 2

hours of free time.

You are giving up 3

hours of free time.

You are giving up

$14.

You are giving up $7.

You are not giving up any

wages.

EXTERNALITIES

• An EXTERNALITY is a side effect of a transaction which affects someone other than the seller or buyer. Externalities can be either POSITIVE (benefit) or NEGATIVE (cost) to the third party.

A new college built in Hamburg

POSITIVE NEGATIVE1. ANOTHER COLLEGE

INSTITUTION FOR KIDS TO ATTEND

2. CREATION OF JOBS3. INCREASE THE TAX

BASE4. NEW CAREERS FOR

KIDS TO MAJOR IN

1. INCREASED DESTRUCTION OF THE ENVIRONMENT

2. MORE TRAFFIC

Nuclear waste disposal plant in Hamburg

POSITIVE NEGATIVE1. CREATION OF JOBS2. INCREASE THE TAX BASE3. GROWING INFLUENCE OF

BUFFALO AREA

1. INCREASED DESTRUCTION OF THE ENVIRONMENT

2. MORE TRAFFIC3. POSSIBILITY OF INCREASED

EXPOSURE TO RADIOACTIVE ELEMENTS

4. BIPRODUCTS OF NUCLEAR WASTE PLANTS

What does the PPF represent?

How much of a good can be produced

The greatest combination of 2 goods

The limits of your industry

How does it affect the you?

It’s your trade-offs with money

It’s their trade-offs in producing

How does it affect an industry?

You are a baker and you have the ingredients to produce the following:

Bread in loaves Muffins (per muffin)

12 09 256 503 750 100

How might this ppc look?

Hint: It would go in graph form on a graph like this: