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1 They probably mean that, given the competing demands on their limited resources, there are other things (a holiday, private school fees, a new computer) that they choose to spend their income on rather than a plasma screen television. Your friend probably means that your tennis game will improve faster if you take individual lessons instead of group lessons. However, individual lessons are also more costly than group lessons, so those people who are less concerned about how rapidly they improve may do better to take group lessons and spend what they save on other things that they value more. The more valuable opportunity is the one that yields the greatest absolute gain. Even though saving $100 on a $2000 plane ticket represents only a 5 percent saving, which is less than the 45 percent saving you would make on the Brisbane ticket, the $100 save is more valuable to you than the $90 saving. Because the price of a movie ticket is a cost the patron must pay explicitly, it tends to be more noticeable than the money that she would fail to earn by seeing the movie. As Sherlock Holmes recognised, it’s easier to notice that a dog has barked than that it has failed to bark. You are wrong to suggest that the album cost you nothing. The astute economic thinker would know to ask the question ‘What would I otherwise have done with the gift voucher?’ If the answer to this question was to let it expire unused, then you would be correct in treating the Black Eyed Peas album as free. It is, however, more likely that you would have used the voucher to buy some other album. If so, the opportunity cost of the Black Eyed Peas album is your reservation price for the album that you would have otherwise purchased. If your tuition payment is non-refundable, it is a sunk cost. If the payment is refundable until a certain date, it is not a sunk cost before that date but becomes one after it. It is impossible to determine whether you should increase the number of times you visit the gym each week based on the information provided. While we know the marginal cost of an additional visit to the gym each week ($15), we know only the average benefit of gym visits at the current number of visits ($30 per week). Sound economic thinking requires that we compare marginal benefits and marginal costs when deciding whether to increase the number of gym visits. The farmer may fail to recognise the costs that may arise in terms of erosion, declining water quality and loss of habitat when trees are removed from the banks of a stream (Pitfall 1). Harvesting the trees may be more attractive to the farmer who places greater weight on costs and benefits that occur now than on costs and benefits that occur in future periods, which is what Pitfall 6 requires us to do.
and the cost of seeing the play—at the moment each must decide—is exactly $10. the cost is $6 per week no matter how many bins are put out. has eliminated that incentive by making sure that neither child can drink more than half the cans. the loss of a ticket is clearly no different from the loss of a $10 bill. A 15 per cent saving on a $10 000 bill is $1500. the costs that have already been incurred become ‘sunk costs’. Dick must therefore give Tom $200 in interest in order for Tom not to lose money on the loan. The cost-benefit principle suggests that you should add four bags of compost and no more. In terms of the financial consequences. or $6 in extra revenue. the benefit of seeing the play is the same in both cases. The benefit of adding an extra bag of compost is the extra revenue you will get from the extra tomatoes that result. The decision should be based on a comparison of the extra benefits and extra costs that will result from completing the project. the question is whether 3 4 5 6 7 8 9 . the two women should make the same decision. each child knows that the cost of not drinking a can of cola is that it is likely to be drunk by his sibling. Adding the fourth bag of compost will result in two extra kilos of tomatoes. Since the relevant costs are higher under the tag system. adding the fifth bag of compost gives only one extra kilo of tomatoes. After all. For the same investment the cafe’s owner should prefer the 2 per cent saving on $100 000 rather than the 15 per cent saving on $10 000. not the proportional change. which more than covers the $5 cost of the extra bag of compost. According to the cost-benefit criterion. The cost of adding a bag of compost is $5.00) minus your cost of doing the job ($3. Lucy must ask herself. In each case. more enjoyable pace. the price of two tickets. the cost of putting out an extra bin is $2. the cost of seeing the play is not $10 but $20. we would expect this system to reduce the number of bins put out for collection. If Tom kept the $2000 and invested it in his business. Under the tag system. Insisting that all projects be completed could result in ‘throwing good money after bad’ and in investments being made by the government for which costs exceed benefits. however.Answers to problems 1 2 The economic surplus from washing your dirty car is the benefit you receive from doing so ($6. Many people seem to feel that in the case of the lost ticket.50). The rules of sound economic thinking suggest that it is the absolute change in the value of costs and benefits that matter. at the end of a year his investment would have resulted in earnings of $200. that is. A 2 per cent saving on a $100 000 bill is $2000. This step permits his children to consume at a slower. $2. Lucy’s statement reflects one of the pitfalls of economic thinking: namely. Jones. In the first case. so the cost of disposing of an extra bin of rubbish is $0. by contrast. so the corresponding revenue increase ($3) is less than the cost of the compost. Each child thus has an incentive to consume rapidly in order to prevent the other from encroaching on his share. At Smith’s house. evaluated at that point in time. However.50. When the newly elected government decides whether to allocate extra funds to complete a particular infrastructure project. ‘What would I otherwise be doing if I didn’t work in my own business?’ The value of the opportunity that she is foregoing is an implicit cost of doing business and should be included when assessing the profitability of Lucy’s business. regardless of the number of the bins. failing to account for all opportunity costs.
Whichever the answer. then. therefore. the benefit of testing the alarm more regularly is the reduction in the value of the expected loss from fire. you should not include the cost of your ticket. otherwise not. since your ticket cost $30. Since the benefit of talking for additional minutes is the same under both plans. Tom will make longer calls under the new plan. 12 13 . And since you both have identical tastes—that is. you should see it. However. it must be the same in both cases. you should compare the benefit of seeing the game (as measured by the largest dollar amount you would be willing to pay to see it) only to those additional costs you must incur to see the game (the opportunity cost of your time and whatever cost you assign to driving through the hailstorm). so people will stop eating when the benefit of eating an extra kilogram falls to $2. since that is the extra cost to them for each extra kilogram of food they eat. compared to 10 cents per minute under the current plan.seeing the play is worth spending $10. the remaining costs Joe must incur to see the game are $25 higher than the remaining costs for you. that is $30 you will never see again. too. It may also be the case that some people are more skilled economic thinkers than others and are better at applying the cost-benefit principle and avoiding its pitfalls. However. If it is. whereas Joe’s will cost only $25. In this case. the marginal cost under the new plan is only 2 cents per minute. In deciding whether to see the game. 10 Since you have already bought your ticket. must weigh the opportunity cost of his time and the hassle of the drive in deciding whether to attend the game. 11 The two phone systems charge exactly the same amount (70 cents) for a seven-minute call. Joe. the $30 you spent on it is a sunk cost. The differences in the choices that people make reflect differences in the costs and benefits that they face. everybody will keep eating until the benefit from eating an extra kilogram of food is equal to $0. The cost associated with more regular alarm testing may also differ depending on factors such as age. Assessment of the size of this benefit will differ across individuals. whether you go to the game or not. the cost of eating an extra kilogram of food is $2. whereas your $30 is a sunk cost—and hence an irrelevant one for you. whether or not you go to the game. It is money you cannot recover. Food consumption will thus be higher at College A. At the moment of deciding. You might think the cost of seeing the game is higher for you. In College B. But he must also weigh the $25 he will have to spend for his ticket. But at the moment of deciding whether to make the drive the $25 is a relevant cost for Joe. since your respective benefits from attending the game are exactly the same—Joe should be less likely to make the trip. In College A.
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