How cost of living varies
by where you live (Ch 2)
 We talked of how $ does not buy the
same amount today as it did in the past.
So we learnt how to adjust for this when
comparing prices, income across time.
 Does a $ buy the same here as it does,
say in Mississippi? How about New York
City? LA?
 Obviously not. Why not? Cost of living
varies across states, even across cities
within a state.
Where you live matters
 It is nice to live in California: the weather,
the people etc.
 But, there is a price to be paid for living
here, higher cost of living (average
compared to other states)
 Let’s assume you make $30 000 now.
 You are offered a job in Arizona for $27
000. If you are indifferent between living
in CA and AZ, do you take the job?
Where you live…
 Depends on what $27 000 will buy in AZ.
 The purchasing power also varies across
states different cost of living
 Generally speaking, cost of living (COL)
is higher in more densely populated
areas compared to rural areas; higher in
areas with faster growth vs. those with
slower growth or no growth at all.
Cost of living indices, 2003
State
Index
State
Index
Arizona
93.80
Nevada
98.60
Alaska
107.60
New York
126.6
California
125.10
Pennsylvania
100.7
Connecticut
102.90
Arkansas
89.20
Georgia
91.30
Utah
96.6
Illinois
96.50
Vermont
111.7
Mass.
100.1
Washington
102.2
US Average = 100
Calculating COL
 Index value of 107.6 indicates that the
cost of living in Alaska is 7.6% higher
than the national average.
 Index value of 89.2 indicates that cost
of living in Arkansas is 10.8% less than
the national average.
 Calculating Cost of Living:
1. AZ index was 93.80, CA was 125.1.
2. Find the ratio (where you live on
bottom): 89.20/125.1 = 0.7498 so
what costs $1 in CA costs $0.75 in AZ.
Calculating COL
3. So if you are making $30 000 in CA,
it’s the same as making:
$30 000 x 0.75 = $22 500 in AZ
4. If you are offered $27 000 in AZ, would
you take it?
Another example: What about the
reverse? Say you were in AZ making
$30 000 and were offered $40 000 in
CA, would you take it?
Another example
 Living in AZ, going to CA:
 Ratio = 125.1/ 89.2 = 1.402
 $30 000 x 1.402 = $42 060
 Would you take it?
 Think of these as “CA dollars” and “AZ
dollars”. Each buys different amounts.
Although the currency is the same and
$1 in CA is also equal to $1 in AZ, but
buys different amounts.
Now You try it!
 I am offered a job in Pennsylvania
making $50 000. I currently live in
Illinois and make $50 000. If I don’t
particularly care where I live and am
only concerned about $$$, should I
take the job?
About Cost of living
 Cost of living varies across states, but
also within each state.
 COL different here in Bakersfield (lower)
compared to LA (higher).
 So when moving, need to consider the
COL between cities rather than between
states.
 Salary Calculator
Time value of money
(Ch 3)
 Cost of living rises over time: $ in
earlier years have greater purchasing
power than $ today
 What about future dollars? Same true:
$ today worth more than $ in future
 Why?
1. Rising cost-of-living
2. Can invest $ today and have more in future
Comparing $ now and
then (Ch 3)
 So how do you account for this?
 Based on interest rate that could have been
earned by investing (opportunity cost of $)
 Should at least cover the expected ↑ in COL
 Table 3: Present value converters (PVC)
for future years and different interest
rates ($ future worth less than $ today,
so values <1)
 Future value x PVC = Present Value (in
today’s $)
Example
 Lucky Von’s aunt passed away leaving him
$100,000 (FV). But he can’t get it until he is 30.
He is currently 20. Getting that lump sum in ten
years is the same as getting how much today?
(Assume interest rate (r) =5%)
 PVC 10 yrs = 0.614
 Present Value (PV) = PVC x FV
 PV = 0.614 x 100 000 = $ 61 400
 Lucky is indifferent b/w receiving $100,000 in
10 years or $61,400 today.
Another example
 Miss Moneypenny just won $10 million.
But the prize will be paid over 20 years,
$500,000 per year.
 Even though $500,000 x 20 = $10 M, not
the same as having $10 M today.
 How much is it really worth in today’s $?
 Let’s assume r = 7%.
 PVC20 = 0.258, PVC19 = 0.277 …PVC1 =0..935
Another example
cont…
 Year 20 PV = 500,000 x 0.258 = $ 129,000
 Year 19 PV = 500,000 x 0.277 =$ 138,500
‫׃‬
 Year 1 PV = 500,000 x 0.935 = $ 467,500
$ 5,297,007
Now you try it!
You have a choice b/w receiving
$10,000 in 4 years or $20,000 in 8
years. Which would you choose if r
= 3%?
PVC8 = 0.789; PVC4 = 0.888
Is a second job
worthwhile? (Ch 4)
 Often when the standard of living is
lower, people want/ need to take a
second job.
 Is it always beneficial?
 Depends, on what needs to be given up
(opportunity cost).
 Often 2 incomes in a household 
needed!
 Question: Should the second adult in a
household take a job?
Second job? (Ch 4)
 Taking into account taxes and other
related expenses, is the second job
really worthwhile?
 Points to consider:
1. Taxes: SS (7.65%)
- Fed income tax  additional salary
taxed at higher rate
- State income tax  same
 second job: taxes can take 22% - 50% of
pay
Second job?
2. Other expenses (measurable)



Clothes
Commute  second car?
Child care?
3. Other costs (not measurable)

Less time for:
 Housework  cleaning, cooking  maid?
 Family time
Second job?
 Benefits:
1.
2.
3.
4.
5.
Extra income (after all expenses)
Away from household
Psychological advantage
Future benefits: SS, retirement
Present benefits: Healthcare?
 Need to consider both benefits and
costs  marginal analysis
Second job?
 Marginal Analysis: Compare the cost
and the benefits of an action. Choose
action if benefits > costs.
 Jack and Jill are married and live with their 3
year old Amy. Jack earns $40,000. Jill is a stay
at home mom. Through a friend, she is offered
a job at CSUB which would pay $30,000 plus
benefits. When she adds up the value of the
benefits, they come out to about $6,000 a year.
But, if she accepts she will have to place Amy
in a daycare which costs $3,500 per year.
Taking into account all extra costs, she
wonders if the job is really worth it?
Jill’s Dilemma
 Benefits;
 Salary
 Fringe benefits
 Total
$30 000
$ 6 000
$36 000
 Costs:
 SS Tax: 0.0765 x 30000 = $2 295
 Fed income tax:
(Need to calculate the difference between taxes when
Jill works and when she does not work.)
Federal Taxes: Jill
works
1.
2.
3.
4.
5.

Family income = $40 000+30 000 = $70 000
Standard deduction (family) =
$ 9 700
Exemptions (3 x 3100)
=
$ 9 300
Taxable Income (1-2-3)
=
$ 51 000
Calculate tax: $14,300 10% =
$ 1 430
($51,000 - 14,300 =) $36,700  15%=
$ 5 505
Federal Taxes
=
$ 6 935
Federal taxes: Jill does
not work
1.
2.
3.
4.
5.
Family income
= $40 000
Standard deduction (family) = $ 9 700
Exemptions (3 x 3100)
= $ 9 300
Taxable Income (1-2-3)
= $21 000
Calculate tax: $14 300 10% = $ 1 430
($21,000 – 14,300=) $6700  15% = $ 1 005
 Federal Taxes
= $ 2 435
Federal Taxes: the difference $4500
If Jill Works:
If Jill does not work:
Difference
$ 6 935
$ 2 435
$ 4 500
State Taxes
$ 1,500
 These vary across states.
 To make things easier, we assume
the difference is simply the tax on
the extra income.
 Assume average rate of 5%, so
extra tax:
 $30 000 x .05 = $1500
Child care
$ 3,500
Need to spend extra on child care
$3500
Commute
$ 1,500
 Actual costs vary depending on how
Jill would get to work.
 She could share a ride with her
friend, or Jack could give her a ride.
 She may have to purchase a new
car or take the bus
 We estimate that this will cost her an
extra $1500 per year
Clothing and food
$ 1,000
 Again we will need to estimate this part as
well.
 She may not have to purchase any new
clothes, or she may have to purchase a
whole new wardrobe.
 She may take lunch from home, or she
may eat at the university cafeteria
 We estimate these costs to be $1 000 per
year
Total Extra Costs






SS
Federal tax
State tax
Child care
Commute
Clothes/ food
$2 295
$4 500
$1 500
$3 500
$1 500
$1 000
$14 295
Net Benefits ($30 000 – 14 295) = $15 705
Approximately: $7.85/hr
Is it worth it?
 Essentially the net gain to them
financially is roughly half of Jill’s pay.
 Question: Is it worth it? Depends.
 What does it depend on?
 Non measurable costs: family time, child in
day care, housework
 Non measurable benefits: feeling of
contribution, time away from home
What did we learn?
 Part of second job pay taxed at higher
rate (27% vs 15%).
 Higher the salary of second job, higher
will be net benefits. Why?
 Many of the costs are fixed, regardless of the
salary: child care, commute, food, clothing
 Some depend on salary: income tax, ss tax
 Generally speaking maybe better off?
TANSTAFL (Ch 5)
 There Ain’t No Such Thing As a Free Lunch
 Scenario: Have $7 000 in the bank. See a car for $7 000.
How many would use the savings to buy the car? How
many would borrow money (and pay interest) to buy the
car?
 Depends on OC.
 Opportunity cost of savings: interest it could have earned.
 Win free tickets to a concert in a radio contest.
 Are the tickets really free? No.
 Their value to you is the opportunity you give up instead.
You give up the time that could have been spent on
studying, gardening etc.
TANSTAFL
 This is true since time and money, similar to
other resources, are limited.
 Given limited resources, choices must be
made. If use the resource in one way, then
need to give up the use in another way.
 Eg. If spend 3 hrs watching TV, and need to get
some work done, perhaps need to sacrifice
some sleep time. So cost of watching TV is
‘what else’ you could have done with the time
 the opportunity cost (value of the next best
alternative).
How much do kids cost?
(Ch 6)
 In the past, we have looked at family composition.
 Many reasons for the make up of the average family,
mostly to do with choice.
 Why do some choose to have large families while others
choose smaller?
 One reason (measurable): cost
 After surveying the population, average costs of raising
kids were calculated.
 Not a measure of what parents ‘should’ spend (normative),
but rather what they actually do spend on average, given
different income levels (positive).
Estimated cost of raising a child
born in 2003 (3.1% inflation)
Child’s
Age
Family Income
Low($) Middle ($)
High ($)
0-2
21000
29420
43750
3–5
23640
33160
49070
6–8
26170
36160
52910
9 –11
28470
39100
57170
12 – 14
34990
46190
66270
15 – 17
38000
51640
75080
Total
172270
235670
344250
pg 32
My kid and my money
go to…
 What is included? Housing, food, clothing, health care,
child care and education.
 Major categories: Housing (33%), food (19%),
transportation (17%)
 Why do the expenses rise over time?
 Inflation (partially)
 Spend more on older kids: entertainment, education,
clothes, toys etc.
 Not much difference between single-parent or two-parent
households.
 Both types of families of similar income spend
approximately the same per child.
Kid Cost
 Child costs are per child, based on two-children
household.
 Families with more children: 3rd child – 15% less than 1st
child; 4th child – 21% less; 5th child – 24% less.
 Why? Economies of scale: as produce more, average cost
falls. As applied here, more kids, more sharing (hand me
downs, toys), lower average cost (buy in bulk)
 What’s not included in the previous table? Time spent with
children.
 Estimates indicate 18 000 hrs for 2 kids up to 18 yrs –
some kind of child care or attention
Kids Cost and Benefits
 Marginal Analysis
 People deciding whether or not to have kids…
 What to consider?
 Costs (both measurable and not measurable)
 Benefits (measurable?)
 What are benefits of having kids?
 Why do people have them?
 When is the decision made?
Kid Care
 Important if considering a second job
 Also important for low-wage earners.
 Typically work irregular hours or at night, hard
to find day care
 Rebates for child-care costs (middle class
families)  does not benefit low-income
families since they generally owe little or no tax
 Poor families with preschoolers spend 18% of
income on childcare, while those above poverty
line spent 7% of their income (1993)
How much is an
education worth? (Ch 7)
 Continuing with OC…
 Going to school vs. working
 Also how much schooling?
 How to decide?
 Again, turn to marginal analysis cost/
benefit
 A correlation between people’s
education and their wage rates
Education Pays
We don’t need no
education…?
Why the difference in
wages?
 Often, education is a signal to the employer that
one can learn and be taught.
 Also, education gives one tools/ skills.
 Generally, without education can only work lowskill jobs which do not pay much.
 Over the years many manufacturing jobs (low
skills) moved overseas, where abundant lowskilled labor  can pay lower wages.
 High tech, high skill jobs stay back  need
education
Obvious question…
 So why does not everyone just get higher
education?
 While benefits are clear, we also need to
consider the costs (both measurable and
unmeasurable)
 Measurable cost: Tuition, textbooks, materials
 Cost has been rising, both at private and public
universities, although faster at private
 Public universities instead increase class size,
reduce full-time faculty, especially with state
budget cuts
Average price of attendance, public and
private universities, selected years
25000
20000
15000
Public
Private
10000
5000
0
1987
1991
1997
1998
1999
2000
2001
PUBLIC COLLEGES & UNIVERSITIES
:
Region
Avg tuition/fees '0405
New England
$6,839
Middle states
$6,300
Midwest
$6,085
Southwest
$4,569
South
$4,143
West
$4,130
*Middle states are defined as NY, NJ, PA, DE, MD
Source: The College Board
The Price of College
 Price paid by students = entire cost?
 No, since education, both private and public is
subsidized  average of $8 200 per student
 What are other costs?
 Just paying tuition does not guarantee an education
 Need to exert effort
 Could instead be working (opportunity cost)
 Compare the benefits (higher pay, satisfaction
from obtaining college degree) to costs (tuition
and other OC)
What’s your time
worth? (Ch 8)
 Continuing along with theme of
OC…
 Time is limited, so it is valuable.
 Every moment can be used in a
productive way, whatever that may
be.
 How do you value your time?
 Depends on what activity you could
have been doing instead.
Time is money…
 If instead of being in class for the two hours, if
you could have been working then the cost of
these two hours is the wage sacrificed.
 If you could instead be watching “Jerry Springer”,
then the cost of being in class is the benefit you
would have received from watching the show.
 Value of time varies across people and across
activities.
I'm so late! I'm so very,
very late!
 To ease calculation, we value time as a fraction
of the person’s wage.
 Since we have to choose, having a value
assigned to time will make the choice a little
easier.
 Generally, people value their ‘free’ time (not
working) between 20 and 70% of their wage.
 Those who do not have a paying wage
(homemakers)  estimated $10 /hr
So many choices, so little
time…
 So when choosing between ‘free’ activities, choose
one which costs the least.
 Eg. W. Rabbit does not have too much free time,
so he values his free time at 50% of his wage. It
costs him $20/ week to get to work. C. Catt and W.
Knight propose they carpool, to save money and to
help out their wonderful land. They calculate it will
cost $8/ week for each to commute. W. Rabbit’s
commute time will increase from 5 hrs a week to 7
hrs. If W. Rabbit makes $14/ hr, should he
carpool?
Example cont…
 W. Rabbit’s free time = 0.5 x 14 = $7
 When commuting alone:


Gas and other expenses
Time costs: $7 x 5
$20

$55
Total
$35
 Carpooling:


Gas and other expenses
Time costs: $7 x 7
$8

$ 57
Total
$49
Another example
 Somebody says “better to shop at
Von’s, Albertson’s and Trader Joe’s
rather than just one, so can take
discounts offered everywhere”.
You spend $50/ week at Trader
Joe’s and it takes you an hour to
shop. If your job pays you $20/ hr
(you value your time at 50%) should
you follow this advice if you can
save 25%/ week, but it takes you an
hour and a half more/ week?
Another example
cont…
 Shopping only at TJ’s:
 Grocery costs
 Time costs: ($20x0.5x1)
 Total
$50
$10
$60
 Shopping all over:
 Grocery costs: ($50 – 0.25x50)
$37.5
 Time costs: ($10 x 2.5)
$25.5
 Total costs:
$63
Now you try it!
 Let’s assume you make $10 an
hour. What percentage of that do
you value your free time?
 Now, evaluate the costs and
benefits of taking the bus instead of
driving to school. Assume a bus
pass costs $25 per month.
Markets…
 In economics, we tie the measure of
our free time to the market.
 Market determines our wage.
 How?
 Supply and demand.
 What is supply?
 What is demand?
Markets cont…
 Why do professional athletes make
so much more than the rest of us?
 Value of contribution
 Let’s consider more closely supply
and demand…
P
Supply and demand
S
EQUILIBRIUM
P*
D
Q*
Q
Forever equilibrium?
 Are prices always in equilibrium?
 Not necessarily.
 Sometimes, events occur in the market such that
prices are not at equilibrium.
 Could be for some reason, the price is higher than
equilibrium, then people are willing to sell more
(compared to equilibrium) and people are willing to
buy less (compared to equilibrium)  surplus.
Forever Equilibrium?
 If price is below equilibrium, then
people are willing to sell less
(compared to equilibrium) but
people are willing to buy more
(compared to equilibrium) 
shortage.
Graphing supply and demand:
In class activity
Graph the
table and find
the
equilibrium
price and
quantity.
Price
Q demanded
Q supplied
$0
19
0
0.50
16
0
1.00
13
1
1.50
10
4
2.00
7
7
2.50
4
10
3.00
1
13
Supply and Demand Together
Demand Schedule
Price
$0.00
0.50
1.00
1.50
2.00
2.50
3.00
Quantity
19
16
13
10
7
4
1
Supply Schedule
Price
$0.00
0.50
1.00
1.50
2.00
2.50
3.00
Quantity
0
0
1
4
7
10
13
At $2.00, the quantity demanded is equal
to the quantity supplied!
Price
Equilibrium of
Supply and Demand
Supply
$3.00
Equilibrium
2.50
2.00
1.50
1.00
Demand
0.50
0
1
2
3
4
5 6
7
8
9 10
11
12
Quantity
Supply and demand
 Not always in equilibrium.
 Can either have shortage or surplus.
 Shortage Q supplied < Q demanded,
because price is too low. How is it fixed?
Price has to rise.
 Surplus  Q supplied > Q demanded,
because price is too high. How is it fixed?
Price has to fall.
Excess Supply
Price
Supply
Surplus
$3.00
2.50
2.00
1.50
1.00
Demand
0.50
0
1
2
3
4
5 6
7
8 9 10
11
12
Quantity
Excess Demand
Price
Supply
$3.00
2.50
2.00
1.50
1.00
Shortage
Demand
0.50
0
1
2
3
4
5 6
7
8 9 10
11
12
Quantity