OPPORTUNITY COST Chapter 1 Section2 How does opportunity cost affect decision making?

– Every time we choose to do something, like sleep in late, we are given up the opportunity to do something less, like study an extra hour for a big test. – When we make decisions about how to spend our scarce resources, like money or time, we are giving up the chance to spend that money or time on something else. Introduction

This section is all about the decisions that we make each and everyday. For example, lets say you wanted to go to the Super Bowl next Sunday. One option would be to buy tickets from a scalper ($ ). The other option is there is a contest on Clearwater Beach where you have to stand on a beach towel for 24 hours straight without leaving the beach towel. If you can do this you can buy tickets to the game for $1.00. What choice would you make?

Trade-Offs The act of giving up one benefit in order to gain another, greater benefit Trade-offs involve things that can be easily measured such as money, property, and time or things that cannot be easily measured, like enjoyment or job satisfaction. Example: If you chose to play a sport at this school, it might prevent you from getting a part-time job, spending time with friends, and/or having time for homework.

Opportunity Cost  Whenever individuals, businesses or governments decide on a course of action, they face many trade offs  One alternative though, is usually more desirable than all others.  The most desirable alternative given up as the result of a decision is called the opportunity cost Example: Every ordinary decision that we make involves an opportunity cost. For each of the following what would you chose? 1.Sleep late or wake up early to go on a trip with friends? 2.Sleep late or wake up early to eat your breakfast? 3.Sleep late or wake up early to work on homework. Your decision for these questions is based on whatever you are willing to sacrifice.

Businesses and Governments Businesses make trade-offs when they decide how to use their factors of production. A farmer who uses his or her land to plant broccoli, for example, cannot use that same land to plant squash. Governments also make trade-offs when they decide to spend their money on military needs instead of domestic ones, and vice versa.

Using a Decision – Making Grid At times, a decisions opportunity cost may be unclear or complicated. Using a decision making grid can help you determine whether you are willing to accept the opportunity cost of a choice you are about to make.

Decision – Making Grid Decision-Making Grid Alternatives Sleep lateWake up early to study Benefits Enjoy more sleep Have more energy during the day Better grade on test Teacher and parental approval Personal satisfaction Benefits forgone Better grade on test Teacher and parental approval Personal satisfaction Enjoy more sleep Have more energy during the day Opportunity CostExtra time to studyExtra time to sleep By looking at this chart we can assume that most practical people would decide to wake up early. We always face an opportunity cost though. When we select one alternative, we have to sacrifice at least one alternative and forgo its benefits

Thinking at the Margin When looking at decisions there is one more characteristic in addition to opportunity cost. Many decisions involve adding one unit or subtracting one unit, such as one minute or one dollar. When you decide how much more or less to do, you are thinking at the margin. – Deciding by thinking on the margin involves comparing the opportunity costs and benefits. – This decision-making process is called a cost/benefit analysis.

To make good decisions on the margin, you must weigh marginal costs against marginal benefits. – The marginal cost is the extra cost of adding one unit such as sleeping an extra hour or building one extra house. – The marginal benefit is the extra benefit of adding the same unit. Once the marginal costs outweigh the marginal benefit, no more units can be added Marginal Costs and Benefits

Making a Decision at the Margin When we looked at the previous chart we looked at it from the “ALL OR NOTHING” approach. You were either going to wake up early to study or sleep late and not study at all that morning. In reality you could decide from among several other options rather than just the two. You could decide to get up one, two, or three hours early to study or sleep. Making a decision about each extra hour would mean that you were thinking at the margin.

Decision Making at the Margin OptionsBenefitOpportunity Cost 1 st hour of extra study timeGrade of C on testOne hour of sleep 2 nd hour of extra study timeGrade of B on test2 hours of sleep 3 rd hour of extra study timeGrade of B+ on test3 hours of sleep

Decision-Making on the Margin Like opportunity cost, thinking at the margin applies not just to individuals, but to businesses and governments as well. – Employers think at the margin when they decide how many workers to hire. – Legislators think at the margin when they decide how much to increase government spending on a particular project.