Economics 103

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Economics 103

• Lecture 8
• Opportunity Cost

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• What is Cost?
• - this is one of the most useful ideas
  in economics
• but it is one of the least
  understood.

The most common notion of cost is historical
cost.
In economics we dont use this notion of cost.
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• We dont use it because often it is irrelevant
  for behavior.

In each case, the historical price is completely
irrelevant for how you behave now.
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• In Economics cost is often called Opportunity
  Cost to highlight the difference with historical
  cost.

Costs depend on the alternatives you face.
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My wife and I decided we could either have a
vacation or a divorce. We chose a divorce
because a vacation only lasts a week, but a
divorce can last a lifetime.

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Why would a loaf of bread cost 1.35? What does
that mean in terms of opportunity cost?
How much does it cost to make, eat, sell a
hamburger
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To figure out the cost of the next best
alternative, you may need to add some costs up.
But you have to wait in line for 10 minutes.
Should this be part of the cost?
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If students dont like tuition increases
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Dont confuse Costs with Bads.
A swimming pool has lot of good things about it

but it also has some bad things.
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The cost of the pool is the value of the next
best alternative.
For example a really nice band saw.
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A nice understanding of Opportunity Cost
Friedman vs. ??
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The Broken Window Fallacy
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Cost Questions

• You find a diamond in your back yard worth 4000.
  You decide
• to put it in a ring for 1000 and keep
  it. Did keeping the ring
• cost you 1000?

2. You buy a ticket for Supertramp for 150.
At the gate a scalper offers you 300 to
buy the ticket. You turn it down. Did it cost
150 to see the band?
3. You own a art shop and youve bought a
painting for 3000 and plan to sell it for
6000. Before you sell you find out the
artist has just died, and his work is now selling
wholesale for 5000. People are phoning you
asking about the painting. Will you act as
if the painting cost you 5000?
4. Why would a volunteer army cost less to a
society than a draft army?
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More Cost Questions.
1. If it rains, is it more costly to use
self-serve pumps?
2. If I hate doing the weeding, but my wife
loves it, is it more costly for me to do
it?
3. Does it cost more for a surgeon to operate on
a poor person?
4. Are costs for a store higher if it owns or
rents its space?
5. If Costco comes along and offers to rent the
store space, did the stores costs increase?
-if costs increase, is this a bad thing?
- costs are not the same as bads.
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Still More Cost Questions
1. If you inherit something, does it cost to use
it?
2. Whats wrong with this conversation
Boy, theres never anyone in this club
It doesnt matter, the owners own the
building and dont have to pay rent.
3. Whats wrong with this conversation
I wonder what he needs to charge to make a
profit. That depends on how much of a
downpayment he made.
4. Who sleeps more high or low wage people?
-teenagers, Nygard case, Lottery winners.
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One Last Cost Question
Movie breaks at Schindlers List . I get a coupon
Flight is delayed from Montreal I get another
flight.
I take back a toaster that doesnt work I get
my money back.
What is going on?
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Some actions involve expenditures that have no
salvageable option.
Non-salvageable costs are called sunk costs
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More Sunk costs examples
Movie about terrorism.
Scheduled release
October 2001.
Cost 70 million, but was not released.
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Aside from the distinction between Sunk and
Ordinary Costs, costs might be either variable
or fixed.
Costs can be any combination of fixed/variable vs
Sunk and Ordinary.
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Suppose you own a Comic Book Store. What examples
of costs would fit into the matrix below?
Heat in the reading room
Custom made sign outside.
special pin given away with every purchase.
Comic books bought from the wholesaler
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We are going to assume that all fixed costs are
sunk, and all variable costs are ordinary costs.
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Airlines dont charge you for pop like they do
for booze. Can that explain why it is so hard to
get
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The distinction between Sunk and ordinary costs
is important because behavior depends on
ordinary costs, not sunk costs.
Suppose you are a TV retailer and you buy 28 sets
for 19600, and as a result you win a free two
week trip to Las Vegas. After you get back you
find out you cant sell one TV. The TVs would
sell for 5600 as junk, and an orphanage has
offered 20,000 for the works. You wonder what
your costs are
Wholesale costs . 19600.
Since its bad business to sell below costs, you
turn the orphanage down. Did you make the
right decision?
Interest for 1month 196
Handling 2000
Advertising . 800
Display Space 1400
Total 23,996