Funds used to make payments on loans, for example, cannot be invested in stocks or bonds, which offer the potential for investment income. 1. 11. Say that you have option A: to invest in the stock market hoping to generate capital gain returns. B) the inverse of the opportunity cost of one more bolt of cloth. Business Strategy. For Round 1, select 10 students to participate in the production of smartphones or tablet com-puters. Often, they can determine this by looking at the expected rate of return for an investment vehicle. The presence of sunk costs can affect future decision-making, if they are large enough. d) I and III only. Does this mean you should never go out? You were willing to pay up to $200 for this ticket, but it only cost you $110. Which of the following was relevant to this decision? An opportunity cost example of trade-offs for an individual would be the decision by a full-time worker to take time off work with a salary of $50,000 to attend medical school with an annual tuition of $30,000 and earning $150,000 as a doctor after 7 years of study. If investment A is risky but has an ROI of 25% while investment B is far less risky but only has an ROI of 5%, even though investment A may succeed, it may not. This consideration of opportunity cost is rooted in an understanding that all resources are scarce. The opportunity cost is the cost of the next best choice, or what we give up to get what we want. 2. Place 20 of the prepared smartphone/tablet cards in the coltan box. Why would one ever buy a gym membership? This isn’t meant to scare you, but rather to emphasize that a rational consumer doesn’t ignore time, but incorporates it into the analysis of any decision they make. D) Unable to determine without knowing input costs. b) I Opportunity cost is the value of something when a particular course of action is chosen. Sometimes it kind of feels like our lives are made up of a countless number of weeks. Similarly, in China, an additional shirt also costs 1/100 worker-years that would have to come at the expense of the production of (1/100 * 10) = 0.1 fewer computers. Considering the value of opportunity costs can guide individuals and organizations to more profitable decision-making. Abilities vs Abilities The opportunity cost of after school violin lessons at a particular school is the ability to join other after school activities such as baseball or the chess club. When you decide, you feel that the choice you've made will have better results for you regardless of what you lose by making it. Given this, what do my monthly SUNK COSTS equal? Consider the two options you may have when you wake up – do you work out or sleep in? You are willing to pay $20 to see the movie and the movie ticket costs $5. The opportunity cost of going to the movie is: 4. No matter which option the business chooses, the potential profit it gives up by not investing in the other option is the opportunity cost. Bottlenecks, for instance, are often a result of opportunity costs. 22. The difference between an opportunity cost and a sunk cost is the difference between money already spent in the past and potential returns not earned in the future on an investment because the capital was invested elsewhere. We have now looked at how to analyze two options, but how do we make the decision? With that analysis it seems like you should go, but so far we have only considered the explicit costs of the experience. Being a rational decision maker means considering the scarcity of all resources associated with an action. But what about our time? Show transcribed image text. The opportunity cost of seeing the movie is equal to: 5. Topic 1: Introductory Concepts and Models. C) 5 computers. D) The economy cannot move to point A. It allows a comparison of estimated costs versus rewards. Sunk costs aren’t exclusive to gym memberships, in fact, the sunk cost fallacy is common in big business and government. As such it should have no impact on future decision making. The conclusion: Sunk costs are irrelevant for decision making. b. shirt in America costs 1/100 worker-years (1 worker working for 1 year), and freeing up the necessary 1/100 worker-years in America would mean (1/100 * 20) = 0.2 fewer computers produced. So in this example we are moving from combination H to combination C (but the way the table is created we stop at D). Also, the total opportunity cost of producing 5 computers, is equal to the individual opportunity cost (or marginal costs) added up. A firm tries to weight the costs and benefits of issuing debt and stock, including both monetary and non-monetary considerations, in order to arrive at an optimal balance that minimizes opportunity costs. For the soap-making opportunity, she anticipates annual revenue of $465,000 and costs for the necessary land, labor, and capital of $395,000 per year. You just may be surprised that your willingness to pay may be well over $100. Buying 1,000 shares of company A at $10 a share, for instance, represents a sunk cost of $10,000. The benefit or value that was given up can refer to decisions in your personal life, in a company, in the economy, in the environment, or on a governmental level. This morning, I was trying to decide whether or not to actually go to the gym. If they're cautious about a purchase, many people just look at their savings account and check their balance before spending money. As an investor, opportunity cost means that your c) III only. 1 Unit of Car: 2 Unit of Computer. This is the amount of money paid out to make an investment, and getting that money back requires liquidating stock at or above the purchase price. Opportunity Cost Calculation in Excel. Normally we are quite good at considering scarcity when it comes to resources and money. For the sake of simplicity, assume the investment yields a return of 0%, meaning the company gets out exactly what it put in. Computers: 20. The opportunity cost of the new design of the product will be the increased cost and its inability to compete on price. If the opportunity cost of producing one car in Japan is 10 computers and the opportunity cost of producing one car in the United States is 5 computers, then the United States has a comparative advantage in computer production. As decision makers, we have to make trade-offs on what we do with finite resources. You were willing to pay up to $350 for this ticket, but it only cost you $100. For her, the opportunity cost of one more ton of corn is A) the ratio of all the bolts of cloth she produces to all the tons of corn she produces. How do we measure time? Opportunity cost accounts for alternative uses of resources such as time and money. If I don’t loan my brother the $10,000, it will stay in my bank account for the year, where it will earn 2% interest. After three hours, the additional benefit from staying an additional half-hour would likely be less than the additional cost. The golf takes four hours to play. c. What is Angela's opportunity cost of 1 mug? Consider the case of an investor who, at the age of 18, was encouraged by their parents to always put 100% of their disposable income into bonds. Which of the following statements about sunk costs is FALSE? A rational consumer would chose to work. It is equally possible that, had the company chosen new equipment, there would be no effect on production efficiency, and profits would remain stable. Assume There Is A Technological Advance In Computers (only). In a typical month I spend about $50 on beer at the Club. Paulie has a comparative advantage in ____ and Vinny has a comparative advantage in _____ A. Similarly, in China, an additional shirt also costs 1/100 worker-years that would have to As a member of UVic’s University Club, I pay $30 per month in membership fees. Tickets cost $100, and the next-best alternative use of your time would be to work in paid employment earning $50 over the evening. Assume the expected return on investment in the stock market is 12 percent over the next year, and your company expects the equipment update to generate a 10 percent return over the same period. b) The $300 I spent on gym clothes. 5 pots . Notice that the $60 is not included as an explicit costs because it is not an additional cost we have to incur as a result of working out. a) II and III only. What is Paulie's opportunity cost of producing a cup of ice cream? (Click To Select) $ C. Between Which Two Consecutive Points Along The PPC Is The Opportunity Cost Of DVDs The Highest? What if your friends were to ask you if you want to go out to the club? III. In our introductory section we identified the concept of scarcity. 10 pots? While financial reports do not show opportunity costs, business owners often use the concept to make educated decisions when they have multiple options before them. 4 Computer. Again, an opportunity cost describes the returns that one could have earned if he or she invested the money in another instrument. Seem high? So the opportunity cost of buying an SUV includes an alternative option, such as buying a less expensive sedan. This shows us something interesting. He has agreed to pay 10% interest on the loan. Production Possibilities and oPPortunity cost Lesson 1 Opportunity Cost To an economist, the true cost of anything is more than the monetary price (the “price tag”) of the good or service. Simply put, the opportunity cost is what you must forgo in order to get something. Practice Questions to accompany Mankiw & Taylor: Economics 9 d. Why is her production possibilities frontier a straight line instead of bowed out like those presented in Chapter 2? 10. D. 3 CDs per article. Classical economists will often assume that utilities can be measured as a hard number. The opportunity cost of choosing this option is 10% - 0%, or 10%. Investing. Opportunity costs are everywhere and occur with every decision made, big or small. If, for example, a company pursues a particular business strategy without first considering the merits of alternative strategies available to them, they might therefore fail to appreciate their opportunity costs. In essence, it refers to the hidden cost associated with not taking an alternative course of action. Often, people don't think about the things they must give up when they make those decisions. The internal rate of return (IRR) is a metric used in capital budgeting to estimate the return of potential investments. Economists focus on the true cost as the op-portunity cost. 5.What can you say about point G? C) $80. Ever heard the expression “we’ve invested too much in this project to back out now?” Even if you have not, it sounds fairly logical – unfortunately it is not. Even though we are willing to pay $100 to go out clubbing, our ‘happiness’ from working is greater. It does not matter that we spend $60 on a gym membership because no matter what we do we can’t get that money back. The opportunity cost of your golf game is: 7. Notice that the $60 is not included as an explicit costs because it is not an additional cost we have to incur as a result of working out. So in this example we are moving from combination H to combination C (but the way the table is created we stop at D). Suppose you have bought and paid for a ticket to see Kanye in concert. How much do you value it? Opportunity costs are truly everywhere, and they occur with every decision we make, whether it’s big or small. The opportunity cost of a given action is equal to the value foregone of all feasible alternative actions. We must consider time as another cost of the action. After new information, they learn of another, richer mine site that they can mine for $4 million, with projected revenues of $8 million. C. 30 Ums. We would say that Plant 1 has a comparative advantage in ski production. c) The fact that I also had to write a 103 midterm exam today. 15. It is important to note that the implicit costs are the benefit of the next best option. The key difference is that risk compares the actual performance of an investment against the projected performance of the same investment, while opportunity cost compares the actual performance of an investment against the actual performance of a different investment. Suppose that you deciding between seeing a move and going to a concert on a particular Saturday evening. 3. Comparing a Treasury bill, which is virtually risk-free, to investment in a highly volatile stock can cause a misleading calculation. Having takeout for lunch occasionally can be a wise decision, especially if it gets you out of the office for a much-needed break. The $75 we could be earning from working is equal to our implicit costs of going out since, rather than going clubbing, we could be making money for the 5 hours. Economists focus on the true cost as the op-portunity cost. This is very simple. The opportunity cost of doing accounting work is the time not spent in other ways, i.e., time such as running a small business or participating in leisure activity. This is your implicit cost for clubbing, or the cost that has been incurred but does not result in a direct payment. Due to scarcity, choices must be made. The problem comes up when you never look at what else you could do with your money or buy things without considering the lost opportunities. The opportunity cost of holding the underperforming asset may rise to where the rational investment option is to sell and invest in the more promising investment. B. For example, moving from point A to point B, we are getting 1 leather jacket, and giving up 2 computers, this means that the opportunity cost of 1 leather jacket is 2 computers (2/1). Opportunity Cost of Production. I. In our previous analysis we refer to the concept of “Total Happiness.” The problem is, happiness is not an easy value to measure. Would Anything Happen To The Opportunity Cost Of Television Sets? Expert Answer 100% (1 rating) Previous question Next question Transcribed Image Text from this Question. Answer: 1/2 pot. The secretary can produce $0 in legal services and $20 in secretarial duties in an hour. Opportunity cost of 1 computer = 10 tons of wheat. Why (not)? To calculate accurately the opportunity cost of an action we need to first identify the next best alternative to that action. B. 2. There are an infinite number of things we could be doing with our time, from watching a movie to studying economics, but for implicit costs we only consider the next best. II. For the remainder of Topic 1, we will refer to happiness as something that can be measured, recognizing that this is rarely as easy as it will appear here. Opportunity Cost is the cost of the next best alternative, forgiven. 11. If you knew that every morning you would wake up and value sleeping more than working out, then a gym pass might not be for you. An opportunity cost would be to consider the forgone returns possibly earned elsewhere when you buy a piece of heavy equipment with an expected return on investment (ROI) of 5% vs. one with an ROI of 4%. 8. The opportunity cost of the new product design is increased cost and inability to compete on price. Indeed, it is unavoidable. The marginal cost of completing the costume is A) $20. Although this result might seem impressive, it is less so when one considers the investor’s opportunity cost. a. If we took them all into account our costs would be infinite. 15. And if it fails, then the opportunity cost of going with option B will be salient. Every choice has a cost (a trade-off). Opportunity cost only measures direct monetary costs. Opportunity cost of 1 computer 10 tons of 100 slope. Although the company’s chosen strategy might turn out to be the best one available, it is also possible that they could have done even better had they chosen another path. Daniel Bernoulli, an economist, first introduced the concept of utility as a means of measuring happiness. Simple – what else could we be doing with that time? When making big decisions like buying a home or starting a business, you will probably scrupulously research the pros and cons of your financial decision, but most day-to-day choices aren't made with a full understanding of the potential opportunity costs. The opportunity cost of seeing the movie is equal to: 6. 3. Solutions: Case Study - The Housing Market, Topic 4 Part 2: Applications of Supply and Demand, Solutions: Case Study - Automation in Fast Food, Introduction to Environmental Protection and Negative Externalities, Solutions: Case Study - The Liberal Gas Tax, Introduction to Cost and Industry Structure, 7.4 The Structure of Costs in the Long Run. the necessary 1/100 worker-years in America would mean (1/100 * 20) = 0.2 fewer computers produced. In economics, risk describes the possibility that an investment's actual and projected returns are different and that the investor loses some or all of the principal. 2 ... computers. The opportunity cost of producing 50 tons of corn is equal to how many tons of beef we could have produced, which of course is 25 tons. What is the opportunity cost to me of the loan to my brother? In this example if you were to go clubbing opportunity costs are: Explicit Costs (cover, drinks and ride home) : $50, Implicit Costs (forgone income from 5 hours) : $75. What is Angela's opportunity cost of 1 pot? Discounted cash flow (DCF) is a valuation method used to estimate the attractiveness of an investment opportunity. The opportunity cost of 20 more berries is 1 rabbit, but if you assume that this is somewhat linear right over here-- it's not so curved, it's somewhat of a line between those 2 points-- then the opportunity cost of 1 berry is 1/20 of a rabbit. Skill: Analytic AACSB: Analytic Skills 10) The concept of opportunity cost can be applied to the analysis of _____ decision-making 10 mugs? Explicit costs are the direct cost of an action, executed either through a cash transaction or a physical transfer of resources. We should do something if the benefits outweigh the costs. What do your sunk costs equal? 20 mugs. The formula for calculating an opportunity cost is simply the difference between the expected returns of each option. School John C Birdlebough High School; Course Title ECO 104; Uploaded By jordancole241999. For the Internet opportunity, she anticipates costs for land, labor, and capital of $3,250,000 per year as compared to revenues of $3,275,000 per year. Just as it is important to understand the costs that should be considered in decision making, it is important to understand what costs should not. Answer: 2 mugs. The opportunity cost of choosing the equipment over the stock market is (12% - 10%), which equals two percentage points. I also spent $300 on extremely stylish gym clothes. An important part of being a rational decision maker is considering opportunity costs. Mutually exclusive is a statistical term describing two or more events that cannot occur simultaneously. In the production possibilities frontier in Figure 1-1, the opportunity cost of producing 10 more computers and moving from point B to point A is A) 15 apples. 1983 >Notable computer: Apple Lisa >Price tag: $9,995 >Inflation adjusted price: $23,794 The Apple Lisa was one of the first commercially available personal computers with … You are only willing to pay $100, and your opportunity costs are $125 so no! The opportunity cost of the new product design is increased cost and inability to compete on price. Assuming there are only two countries, Country A can produce 10 tons of wheat or 20 tons of rice, while Country B can produce 5 tons of wheat or 15 tons of rice. Consider a mining company that has invested $5 million in the infrastructure of a mine. Assume the company in the above example foregoes new equipment and instead invests in the stock market. Assuming that it is impossible to resell the Lady Gaga ticket, what is the minimum value you would have to place on a night at the opera, in order for you to choose the opera over Lady Gaga? Which of the following statements about opportunity costs is TRUE? Country 1 can produce either 10 cars or 20 computers whereas Country 2 can produce 22 cars or 30 computers with available resources. Hi-Tech Inc. has several outdated computers that cost a total of $8,900 and could be sold as scrap for $2,300. I. Thus, while 1,000 shares in company A might eventually sell for $12 a share, netting a profit of $2,000, during the same period, company B increased in value from $10 a share to $15. Opportunity Cost=FO−COwhere:FO=Return on best foregone option\begin{aligned} &\text{Opportunity Cost}=\text{FO}-\text{CO}\\ &\textbf{where:}\\ &\text{FO}=\text{Return on best foregone option}\\ &\text{CO}=\text{Return on chosen option} \end{aligned}​Opportunity Cost=FO−COwhere:FO=Return on best foregone option​. Over the next 50 years, this investor dutifully invested $5,000 per year in bonds, achieving an average annual return of 2.50% and retiring with a portfolio worth nearly $500,000. For example, if option A could earn you $100, and option B could earn you $80, then option B has an opportunity cost of $20 because $100 minus $80 is $20. tshirts; ice cream. Pages 30. As economists, we want to measure the happiness you will get from this experience by finding your maximum willingness to pay. 0 Computers. What is the opportunity cost of one basketball in terms of soccer balls when moving from point B to point C? Understanding the potential missed opportunities foregone by choosing one investment over another allows for better decision-making. With this willingness to pay reflected in the table, the better option is to Sleep-In, with an opportunity cost of $20. Consider the following image that shows the number of weeks an average human lives. I am considering loaning my brother $10,000 for one year. I. Sunk costs are those that cannot be recovered, no matter what future action is taken. The cost of the dinner is $20 and you value the experience of having dinner with your friend at $60. 1. In this scenario, investing $10,000 in company A returned $2,000, while the same amount invested in company B would have returned a larger $5,000. II. By the end of this section, you will be able to: Economics looks at how rational individuals make decisions. Creative Commons Attribution 4.0 International License, Understand the three step process for making binary decisions, Calculate the opportunity cost of an action, Understand how sunk costs influence our decision making, Find your willingness to pay (or wage you would earn) from the option you are considering and the next best alternative, Subtract the explicit costs from each option to find your happiness, Choose the option with that makes you happier, If benefits > costs, this is the right choice. Because opportunity cost is a forward-looking consideration, the actual rate of return for both options is unknown today, making this evaluation in practice tricky. If you were not playing golf you could be working and earning $40 per hour. 3) Jane produces only corn, measured in tons, and cloth, measured in bolts. 1. Not at all. Production Possibilities and oPPortunity cost Lesson 1 Opportunity Cost To an economist, the true cost of anything is more than the monetary price (the “price tag”) of the good or service. Simply put, the opportunity cost is what you must forgo in order to get something. A ticket costs $15, and the next-best alternative use of your time would be to go to a concert which costs $80 and you value at $100. Suppose that you are willing to pay $350 to see Leonard Cohen play at the Save-On-Foods Arena. Overview: Opportunity Cost : Type: Decision Making. The opportunity cost of something is whatmust be given up to acquire it. An explicit cost represents a clear direct payment of cash (whether actual cash or from debit, credit, etc). On the day of the concert, a friend offers you a free ticket to Lady Gaga instead. The economic, or opportunity, cost of doing accounting work is measured by computing the monetary amount that the owner’s time would be worth in its next best use. Society’s wants are unlimited, but ALL resources are limited (scarcity). Also, the total opportunity cost of producing 5 computers, is equal to the individual opportunity cost (or marginal costs) added up. III. 3. 0.73 Unit of Car. In other words, explicit opportunity costs are the out-of-pocket costs of a firm. B. In economics, we want to place a value on each different opportunity we have so we can compare them. The opportunity cost of the first 200 pairs of skis is just 100 snowboards at Plant 1, a movement from point D to point C, or 0.5 snowboards per pair of skis. c) III only. Opportunity Cost BK-CEE-ECONOMICS-131302.indb 1 13-06-2014 03:23:20. A) 25 computers. So we can add up the individual MC comps for each of these rows and we get 15 (1+2+3+4+5). b) I and III only. A firm incurs an expense in issuing both debt and equity capital to compensate lenders and shareholders for the risk of investment, yet each also carries an opportunity cost. If the selected securities decrease in value, the company could end up losing money rather than enjoying the expected 12 percent return. What Is The Opportunity Cost Of The First 20 Computers? B) 15 computers. Well in this case, it might be a bad idea. What is a simple definition of opportunity cost? A ticket costs $10, and the next-best alternative use of your time would be to go to dinner with a friend. B) $60. Opportunity cost is a very important concept in economics, but it is often overlooked by investors. Daniel Bernoulli, an economist, first introduced the concept of ... With this willingness to pay reflected in the table, the better option is to Sleep-In, with an opportunity cost of $20. III. It is important to compare investment options that have a similar risk. In other words, money received in the future is not worth as much as an equal amount received today. might outweigh the additional cost (the opportunity cost). A sunk cost is a cost that no matter what is unrecoverable. Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows over a period of time. a) The $40 that I paid the gym this month. First Year $250 (half of $500) x 20% = $50 expense claim. They could be updated for an additional $1,200 and sold. Types of opportunity costs Explicit costs. While the opportunity cost of either option is 0 percent, the T-bill is the safer bet when you consider the relative risk of each investment. So how do you ‘spend’ your time? We can lay the process out in three steps: If we want to change this into the process for a binary decision (yes or no): It is important to note that not all decisions are binary.

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