Opportunity cost: examples

Opportunity cost: examples

Opportunity cost is the value of the sacrifice you make to get something you want. From an economics perspective, "cost" and "economic cost" mean the same thing as "opportunity cost."

Consider the following examples:

1. Our family can get maybe one more year out of our current car, but some friends have encouraged us to go ahead and get a new car now instead of waiting a year. We figure we'll need about $5,000 for a down payment. Option 1: Our friends offer to loan us the $5,000 at 4% interest for the year. Option 2: We can use $5,000 from our own savings account, which earns us 4% interest per year.
Question: How do the costs to us of these two options compare? Explain.

    2. A few years ago, Bruce ranked three available options as follows:
    1st choice: pay $16,000 tuition and finish a Master's degree in fine arts at the California Institute of the Arts.
    2nd choice: earn $14,000 working part-time managing a small local theater and spend his spare time pursuing his theater hobby as a volunteer director of small-theater plays.
    3rd choice: earn $34,000 working full-time renewing yellow page advertisements for PacBell.
    Question: What is the minimum value of Bruce's opportunity cost for pursuing his first choice?

3. In the former Soviet Union, the government set artificially low prices on many basic necessities such as potatoes. As a result, a smaller quantity of potatoes was provided by farmers, and customers waited in long lines to buy the potatoes that were available.
Question: Do you think the government's price policy raised, lowered or had no effect on a typical buyer's economic cost of potatoes? Explain.

    4. Consider the following information reported in the "Fees and Expenses" section of the 2009/10 College Catalog (http://departments.oxy.edu/registrar/catalog/fees.html): Tuition and Fees: $38,935; Room and Board: $11,360; Books and supplies, special fees, and personal expenses: $3,258. These total $53,553. In considering the economic cost of your education:
    Question 1: Should any of the listed items be reduced in value or deleted? If so, which one(s)?
    Question 2: Should any items be added to the list? If so, what?

Responding to incentives: examples

The "benefit-cost rule" or "golden rule" of economic decision making: make choices that you expect will increase your benefits more than your costs.
Economists assume that rational individuals use this rule to guide their decision making (even without thinking about it directly). Economists can use the rule to help explain how people respond to incentives and how they change their behavior whenever their expected additional benefits and/or costs change.

Try applying the benefit-cost rule to each of the following:

    1. The decision to attend college: Why go to college now rather than when you are much older?
    1a. Will your expected benefits be larger or smaller if you wait? Why?
    1b. Will your expected costs be larger or smaller if you wait? Why?

    2. Fact1: Auto safety regulations have increased considerably since the 1960s.
    Fact2: Over the same period of time, studies indicate that the rate of driver fatalities has not changed much, and the rate of pedestrian fatalities has increased.
    Reconcile Fact1 and Fact2.

3. Account for the following apparent paradox: All else equal, homeowners with fire insurance experience household fires more frequently than homeowners without it.

    4. Fact1: California currently has a "three strikes and you're out" law which raises the penalty for criminals convicted of a third felony offense to a mandatory prison sentence of 25 years-to-life.
    Fact2: An article in the Los Angeles Times reported that some law-enforcement officials have blamed the law for an increase in the level of violence committed by third-time offenders.
    Reconcile Fact1 and Fact2.