Chapter 1
Section 2: Opportunity Costs
Trade offs
• Alternatives that we give up whenever
we choose one course of action over
another
• Individuals & trade offs
–Every decision involves a trade off
• Businesses & trade offs
–Decisions that business people make
about how to use land, labor, &
capital resources also creates trade
offs
• Society & trade offs
–Guns or butter
• A country that decides to
produce more military goods has
fewer resources to devote to
consumer goods & vice versa
Defining Opportunity Cost
• Most desirable alternative given up
as a result of a decision
• Every ordinary decision that we
make everyday involves an
opportunity cost
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
• Economists encourage us to consider the
benefits and costs of our decisions.
Karen’s Decision-making Grid
Alternatives
Sleep late
Wake up early to study
Benefits
• Enjoy more sleep
• Have more energy during the day
• Better grade on test
• Teacher and parental approval
• Personal satisfaction
Decision
• Sleep late
• Wake up early to study for test
Opportunity cost
• Extra study time
• Extra sleep time
Benefits forgone
• Better grade on test
• Teacher and parental approval
• Personal satisfaction
• Enjoy more sleep
• Have more energy during the day
Making the decision
• With each new situation, the opportunity
costs & benefits change
• We always face opportunity costs
–When we select one alternative, we have
to sacrifice at least one alternative &
forgo its benefits
–By recognizing what we are sacrificing,
we can decide whether the decision is
worth it
Opportunity Cost:
the foregone alternative
Think: “next-best”
SCARCITY IS: EVEN IN THE
FACE OF ABUNDANCE . . .
What’s scarce when you’re
in the Mall of America?
at the all-you-can-eat buffet?
Opportunity Cost Analysis
What was the 1st decision you
made this morning?
Opportunity Cost Analysis
Decision Maker: YOU
Alternatives:
Perceived
Benefits
Choice
Opp. Cost
Benefits Refused
Get Up Now
Don’t Get Up
Now
Opportunity Cost Analysis
Decision Maker: YOU
Alternatives:
Perceived
Benefits
Choice
Opp. Cost
Benefits Refused
Get Up Now
Shower
bkfst
don’t rush
On time coffee
Don’t Get Up
Now
More sleep
Opportunity Cost Analysis
Decision Maker: YOU
Alternatives:
Perceived
Benefits
Choice
Opp. Cost
Benefits Refused
Get Up Now
Shower
bkfst
don’t rush
On time coffee
Don’t Get Up
Now
More sleep
X
X
Opportunity Cost Analysis
Decision Maker: YOU
Alternatives:
Perceived
Benefits
Choice
Get Up Now
Shower
Coffee
rush
On time
bkfst
don’t
X
Opp. Cost
X
More sleep
Benefits Refused
Don’t Get Up
Now
Thinking at the Margin
• Many decisions involve adding
one unit or subtracting one unit
Making a decision at the margin
• When you decide how much more or less
to do, you are thinking at the margin.
Options
Benefit
Opportunity Cost
1st hour of extra
study time
Grade of C on
test
1 hour of
sleep
2nd hour of extra
study time
Grade of B on
test
2 hours of
sleep
3rd hour of extra
study time
Grade of B+ on
test
3 hours of
sleep
Cost & benefit at the margin
• Such a comparison could help
someone decide how much
money to spend on a car, how
many hours to work, & how
much time to spend watching
TV
• Cost/Benefit Analysis
–Decision makers just have to
compare the opportunity costs & the
benefits
• What they will sacrifice & what
they will gain
• Once the opportunity cost
outweighs the benefits, no more
units should be added