Opportunity Cost and

1
Chapter 3
Opportunity Cost and The Supply of Goods
2
Chapter Outline

• Introduction
• Costs Are Valuations
• Producers Costs As Opportunity Costs
• Case Studies in Opportunity Cost

3
Chapter Outline

• Costs and Actions
• The Cost of a Volunteer Military Force
• The Irrelevance of Sunk Costs
• Marginal Opportunity Costs

4
Chapter Outline

• Marginal and Average Costs
• Cost as Justification
• Costs and Supply
• Price Elasticity of Supply

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Introduction

• Opportunity Cost
• The value sacrificed in order to obtain a good or
  service
• Cost
• The value of sacrificed opportunities

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Costs Are Valuations

• Supply, like demand, is based on valuations.

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Costs Are Valuations

• Costs of Actions
• The value of the alternative opportunity that is
  sacrificed in order to take that action

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Costs Are Valuations

• Cost of Goods/Services
• Goods/services forgone when an alternative is
  chosen

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Producers CostsAs Opportunity Costs

• Economizing is the same for producers and
  consumers.

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Producers CostsAs Opportunity Costs

• Question
• Why does it cost more to produce a ten-speed bike
  than a redwood picnic table?

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Producers CostsAs Opportunity Costs

• Question
• Why did the producers of the bike use the inputs
  in their chosen combination?

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Producers CostsAs Opportunity Costs

• Question
• Why did it cost the producers, in monetary terms,
  whatever it did to use these inputs?

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Producers CostsAs Opportunity Costs

• Cost of producing a bike
• Determined by the cost of forgone opportunities
  of the various resources

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Producers CostsAs Opportunity Costs

• Question
• Why would a large firm moving into a small town
  employing many people drive up the cost of hiring
  people?

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Producers CostsAs Opportunity Costs

• Land Prices
• Determined by the perceived alternative
  opportunities

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Producers CostsAs Opportunity Costs
P
Q
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Case Studiesin Opportunity Cost

• Question
• Why has the cost of getting a haircut increased
  so much in the last 50 years?

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Case Studiesin Opportunity Cost

• Question
• Why is it often harder to find a teenage
  babysitter in a wealthy residential area than in
  a low-income area?

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Case Studiesin Opportunity Cost

• Question
• Why did the cost of obtaining a college education
  rise so steeply for many years after World War II?

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Case Studiesin Opportunity Cost

• Question
• Why does the high-school dropout rate decrease
  during a recession?

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Case Studiesin Opportunity Cost

• Question
• Why are poor people more likely to travel between
  distant cities by bus and wealthy people by air?

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Case Studiesin Opportunity Cost

• Question
• Is a business owner correct in assuming that
  his/her own labor is free to the firm?

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Costs and Actions

• A thing cannot have a cost.
• Only actions (or decisions) have costs.

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Costs and Actions

• Questions
• What is the cost of a baseball bought at the
  store?
• What does a baseball caught at the ball park cost?

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Costs and Actions

• There are no objective costs.
• Costs are different for different people.

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The Cost of a Volunteer Military Force

• Question
• What does a conscripted and a volunteer army
  cost
• Taxpayers?
• Enlisted personnel?
• Congress?
• The Pentagon?

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Supply Curve ofMilitary Volunteers
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20
16
Annual Wage (in thousands of dollars)
12
8
4
1
2
3
4
5
0
Number of Military Personnel (in millions)
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The Cost of a Volunteer Military Force

• Question
• Does a military draft reduce the cost of
  maintaining a military establishment?

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The Irrelevance of Sunk Costs

• Like the value of goods, costs are valued at the
  margin.

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The Irrelevance of Sunk Costs

• Questions
• What is the cost of a meal?
• What if you dont like the food?

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The Irrelevance of Sunk Costs

• Sunk Cost
• The cost of the meal
• Possibly
• The difference between what you paid for it and
  how much you could sell it for

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The Irrelevance of Sunk Costs

• Marginal costs are the costs that matter in
  decision making.
• They always lie in the future.

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The Irrelevance of Sunk Costs

• Costs must provide an opportunity for choice.

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Marginal Opportunity Costs

• All opportunity costs are marginal costs.
• All marginal costs are opportunity costs.

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Marginal Opportunity Costs

• Summary
• Only actions have costs.
• All costs are costs to someone.
• All costs lie in the future.

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Marginal and Average Costs
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Marginal and Average Costs
Number of Total Cost of Marginal Cost of Average
Cost of Zercs Produced Producing Zercs the Last
Zerc Producing Zercs
42 4,200 43 4,257 44 4,312 45 4,365
100 99 98 97
57 55 53
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Marginal Opportunity Costs

• Marginal cost is the consequence of action.
• Question
• What happens if a companys revenue is not enough
  to cover its average costs?

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Cost as Justification

• Questions
• Do sellers have a right to cover their costs?
• Do they have a right to charge prices
  significantly above their costs?
• Why would they sell below cost?

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Cost as Justification

• Cost is a function of
• Demand
• Supply

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Costs and Supply

• Supply curves illustrate marginal costs that must
  be covered.

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Price Elasticity of Supply
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Price Elasticity of Supply

• Question
• Is it possible to have a perfectly inelastic
  supply curve?
• Does it take time to increase supply?

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End of Chapter 3