Chapter 1
Thinking Like An Economist
Chapter 1, Opportunity Cost Q.1
Edmond, Gary and Eason are your classmate in Economics
class. On Valentine’s Day, each one of them ask you out at
the same time. You are now facing 3 choices: 1) watch an
opera with Edmond, 2) watch a concert with Gary or 3) dine
out with Eason. Your choice of dating depending on the
degree of handsomeness among the three. From your point
of view, Edmond is very handsome; Gary is average; Eason
is ugly. Obviously, you prefer 1) than 2) and 2) than 3). Your
opportunity cost to go out with Edmond is,
a. Watch a concert with Gary
b. Dine out with Eason
c. Watch a concert with Gary and Dine out
with Eason
Chapter 1, Opportunity Cost
(Q.1)
• Opportunity cost: the dollar value of your next best
alternative forgo in order to take certain activity
• It is not the combined value of all possible activities, only the
value of your next best alternative
• It depends on how individual rank their choices, based on
their preferences
Chapter 1, Opportunity Cost (Q.1)
Edmond, Gary and Eason are your classmate in Economics
class. On Valentine’s Day, each one of them ask you out at
the same time. You are now facing 3 choices: 1) watch an
opera with Edmond, 2) watch a concert with Gary or 3) dine
out with Eason. Your choice of dating depending on the
degree of handsomeness among the three. From your point
of view, Edmond is very handsome; Gary is average; Eason
is ugly. Obviously, you prefer 1) than 2) and 2) than 3). Your
opportunity cost to go out with Edmond is,
a. Watch a concert with Gary
b. Dine out with Eason
c. Watch a concert with Gary and Dine out
with Eason
Chapter 1, Opportunity Cost (Q.2)
• You won a free ticket to see an Eason Chan concert (which has
no resale value).
• Andy Lau is performing on the same night and is your nextbest alternative activity. Ticket to see Andy costs $40/ticket.
• On any given day, you would be willing to pay up to $50 to see
Andy.
• Assume there are no other costs of seeing either performer.
Based on this information, what is the opportunity cost of
seeing the Eason Chan concert? (a) $0, (b) $10, (c) $40, or (d)
$50.
Chapter 1, Opportunity Cost (Q.2)
• Opportunity cost, by definition, the opportunity cost of an activity is the
value of what must be forgone in order to undertake the activity.
• In other words, the opportunity cost to watch Eason’s concert is to
forgo the “net benefit” you will get by watching Andy’s.
 What is the “net benefit” of watching Andy’s?
 “On any given day, you would be willing to pay up to $50 to see Andy.”
• Willingness to pay reflects how much you could benefit from the
action or how much does it worth to you express in dollar term
• In this case, by watching Andy’s concert will give you $50 worth of
enjoyment
• “Ticket to see Andy costs $40/ticket.”
• Therefore, the “net benefit” is $50 - $40 = $10
• This is your opportunity cost must be forgone by watching Eason
Chan concert
• Ans. (b)
Chapter 1, Opportunity Cost (Q.3)
• You won a free ticket to see an Eason Chan concert (which has
no resale value).
• Andy Lau is performing on the same night and is your nextbest alternative activity.
• On any given day, you would be willing to pay up to $50 to see
Andy.
• Assume there are no other costs of seeing either performer.
Based on this information, what is the opportunity cost of
seeing the Eason Chan concert? (a) $0, (b) $10, (c) $40, or (d)
$50.
Ans: (d)
Chapter 1, Opportunity Cost (Q.4)
• You won a free ticket to see an Eason Chan concert (which has
no resale value).
• Andy Lau is performing on the same night and is your nextbest alternative activity.
• Ticket to see Andy costs $50.
• On any given day, you would be willing to pay up to $50 to see
Andy.
• Assume there are no other costs of seeing either performer.
Based on this information, what is the opportunity cost of
seeing the Eason Chan concert? (a) $0, (b) $10, (c) $40, or (d)
$50.
Ans: (a)
Chapter 1, Additional Question 1
• You own and manage your own fruit stand. You can grow
your own apples to sell as shown in the following table, or
you can buy apples to sell at $0.2 per pound. For every hour
you work growing apples, you must pay someone $6 per
hour to run the fruit stand.
• How much time will you spend growing apples?
Hours worked
Total Pounds of Apple
0
0
5
200
10
400
15
500
20
620
25
680
30
700
35
720
40
730
Solution to Chapter 1, Additional Question
• To find the answer, you will need to apply the ‘Cost-Benefit’
Principle.
• To determine how many hours to work on growing apples,
find
i) MARGINAL COST of each ‘5 Hour’ unit spent on growing
apples
ii) MARGINAL BENEFIT of each ‘5 Hour’ unit
• The optimal amount of hours to work on growing apples is at
the point when MB>MC
• That is, we continue to spend the extra 5 hours as long as MB
> MC. Stop otherwise
Solution to Chapter 1, Additional Question
• Calculating Marginal Cost of growing apples.
• Bear in mind that the timescale on growing apples is
calculated in ‘5 hour’ units.
• So to find MC is to calculate the extra cost incurred in 1 more
‘5 hour’ unit of growing apples.
• In this case, when you work on the farm for 5 hours, you have
to pay someone $6/hr, you are giving up $6 x 5hrs, which is
$30.
• In this question, MC is the same for all ‘5 hour’ units.
• Adding this to the table…
Solution to Chapter 1, Additional Question
Hours
worked
Total Pounds of Apple
Marginal Cost
($)
0
0
-
5
200
30
10
400
30
15
500
30
20
620
30
25
680
30
30
700
30
35
720
30
40
730
30
Solution to Chapter 1, Additional Question
• Calculate the MARGINAL BENEFIT of each ‘5 hour’ unit.
• The benefit from growing apples is the $.20 per pound of
apples saved by growing them rather than purchasing them.
• For each extra unit of work, there is an extra number of
apples grown.
• For the first ‘5 hours’ of work, we get 200 apples.
Total amount saved 200 apples x $.20 per pound
• For the second ‘5 hours’ of work, number of apples increases
by 400 – 200 = 200.
Total amount saved 200 apples x $.20 per pound
• Adding to the table…
Solution to Chapter 1, Additional Question
Hours Total Pounds
worked
of Apple
0
0
Marginal
Benefit
($)
-
Marginal
Cost
($)
-
5
10
15
200
400
500
40
40
20
30
30
30
20
25
30
620
680
700
24
12
4
30
30
30
35
40
720
730
4
2
30
30
Solution to Chapter 1, Additional Question
• The optimal time on growing apples is at the point where
MB > MC.
• The optimal amount of time is therefore working 10 hours on
apples.
• Because the 10th – 15th unit will result in a loss (MC > MB)
Chapter 1, Problem 3
Residents of your city are charged a fixed weekly fee of
$6 for garbage collection. They are allowed to put out as
many cans as they wish. The average household disposes
of three cans of garbage per week under this plan.
Now suppose that your city changes to a “tag” system.
Each can of refuse to be collected must have a tag affixed
to it. The tags cost $2 each and are not reusable.
What effect do you think the introduction of the tag
system will have on the total quantity of garbage
collected in your city? Explain briefly.
Solution to Problem 3 (1)
• Initially the city has imposed a lump-sum fee of $6 per week for
garbage collection
– No garbage = $6
– 1 bag of garbage = $6
– 2 bags of garbage =$6…
– Pay $6 regardless the number of garbage bag disposes
– Extra cost of an additional bag of garbage =$0
• Now the city imposes a pay-as-you-go fee for garbage collection
called “tag system.” $2 for each tag.
– No garbage =$0
– 1 bag of garbage =$2
– 2 bags of garbage =$4…
– Extra cost of an additional tag (bag of garbage) =$2
Solution to Problem 3 (2)
• The initial plan is more
favourable to residents
who have so much
garbage
• The current plan is more
favourable to residents
who have less garbage
Initial plan
(lump-sum)
Current Plan
(Pay-as-you-go)
2 bags = $6
2 bags = $4
3 bags = $6
3 bags = $6
4 bags = $6
4 bags = $8
5 bags = $6
5 bags = $10
6 bags = $6
6 bags = $12
Solution to Problem 3 (3)
• Suppose now the pay-as-you-go plan is effective,
residents who discharge less garbage are favoured
• All residents are now induced to reducing their garbage
so as to avoid the marginal cost of disposal of $2 for
which it was initially zero
• The total quantity of garbage collected will decrease
• The new garbage disposal system functions well in
reducing amount of garbage which in turn produces a
positive impact on the environment
Chapter 1, Problem 8
You and your friend Joe have identical tastes. At 2pm, you go to
the local Ticketmaster outlet and buy a $30 ticket to a basketball
game to be played that night in Syracuse, 50 miles north of your
home in Ithaca.
Joe plans to attend the same game, but because he cannot get to
the Ticketmaster outlet, he plans to buy his ticket at the game.
Tickets sold at the game cost only $25, because they carry no
Ticketmaster surcharge. (Many people nonetheless pay the
higher price at Ticketmaster, to be sure of getting good seats.)
At 4pm, an unexpected snowstorm begins, making the prospect
of the drive to Syracuse much less attractive than before (but
assuring the availability of good seats).
If both you and Joe are rational, is one of you more likely to
attend the game than the other?
Solution to Problem 8 (1)
• You:
- You buy the ticket from Ticketmaster outlet, so $30 is sunk
cost. You have already paid this price and cannot recover.
You should not consider this as your cost of not going to the
game.
- In deciding whether to see the game, you should compare
the benefit to see the game with the additional cost to attend
this game.
- That is, the opportunity cost of your time and whatever cost
you assign to driving through the snowstorm.
Solution to Problem 8 (2)
• Joe:
-The opportunity cost to attend the game is,
-The opportunity cost of Joe’s time and whatever cost Joe assigns to
driving through the snowstorm PLUS the ticket price. Since, he
buys the ticket at door and he needs to spend $25 if he attends the
game.
- Therefore, the costs to Joe to attend the game is $25 higher than
your cost to attend the game.
- the benefit to attend the games are the same for the two.
Thus, Joe is more likely not to attend the game.
- Note: You may think the cost of seeing the game is higher for you
since your ticket costs is $30 and only $25 for Joe. However, when
deciding whether to make the drive, the $25 is a relevant cost for
Joe, whereas your $30 is a sunk cost and is irrelevant to you.
Chapter 1, Problem 9
• For each long-distance call anywhere in the
continental United States, a new phone service will
charge users 30 cents per minute for the first 2
minutes and 2 cents per minute for additional
minutes in each call.
• Tom’s current phone service charges 10 cents per
minute for all calls, and his calls are never shorter
than 7 minutes. If Tom’s dorm switches to the new
phone service, what will happen to the average
length of his calls?
Solution to Problem 9 (1)
New Plan
Current Plan
1st two minutes
$0.30 per minute
$0.10 per minute
Next two minutes
$0.02 per minute
$0.10 per minute
• If Tom talks exactly 7 minutes,
-- Both service plans charge exactly the same amount - $0.70 for
seven minutes
• If Tom talks beyond 7 minutes,
– Under the current service plan, the marginal cost is $0.10 per
minute
– Under the new service plan, the marginal cost is only $0.02 per
minute
• Since Tom never talks on phone shorter than seven
minutes, he will be benefited from a new lower marginal
cost under the new service plan
Solution to Problem 9 (2)
• Suppose the new service plan is now effective.
Will Tom change his behaviour?
– A lower marginal cost will encourage Tom to talk
longer under the new phone service plan.
End of Chapter 1