1/18/20091Topic 3: Balancing benefits and costsUSC MarshallBalancing benefits and costs•Principles of optimization– How to maximize or minimize a function•How optimization relates to individual choice– When a decision problem is framed right, it almostUSC MarshallWhen a decision problem is framed right, it almost always comes down to maximizing net benefit (total benefit minus total cost)•The concepts of– Marginal benefit and marginal cost– Opportunity costBalancing benefits and costs•Example: You need to decide how much time to devote to studying for this course. Assume that we can attach a monetary value to the time/day you devote to the course as follows:Hours Invested0123456789USC Marshall•If you have nothing else to do, how many hours/day should you study? Total Benefit0152839485560636463
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1/18/20092Balancing benefits and costs•In all likelihood, you do have something else to do in addition to studying for this course. Suppose that each hour you do not study, you engage in more fun activities, and you attach a monetary value of $6 to each hour you spend not studying.ThiltthtittfUSC Marshall– This value captures the opportunity cost of your time•How many hours should you study now?Balancing benefits and costsHours studyingTotal BenefitTotal Cost000115622812USC Marshall33918448245553066036763428644896354Balancing benefits and costs•Alternative approaches?– Use marginal analysis•Marginal benefit: The increase in total benefit resulting from increasing time invested by one USC Marshallhour•Marginal cost:The increase in total cost resulting from increasing the time invested by one hour