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lecture4 - benefits and costs - handout

# lecture4 - benefits and costs - handout - Topic 3 Balancing...

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1/18/2009 1 Topic 3: Balancing benefits and costs USC Marshall Balancing 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 almost USC Marshall When 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 cost Balancing 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 Invested 0 1 2 3 4 5 6 7 8 9 USC Marshall If you have nothing else to do, how many hours/day should you study? Total Benefit 0 15 28 39 48 55 60 63 64 63

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1/18/2009 2 Balancing 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. Thi l t th t it t f USC Marshall – This value captures the opportunity cost of your time How many hours should you study now? Balancing benefits and costs Hours studying Total Benefit Total Cost 0 0 0 1 15 6 2 28 12 USC Marshall 3 39 18 4 48 24 5 55 30 6 60 36 7 63 42 8 64 48 9 63 54 Balancing benefits and costs Alternative approaches? – Use marginal analysis Marginal benefit: The increase in total benefit resulting from increasing time invested by one USC Marshall hour Marginal cost: The increase in total cost resulting from increasing the time invested by one hour