01. Opportunity Cost

01. Opportunity Cost - Opportunity Cost Money talks, but it...

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Opportunity Cost Money talks, but it don’t sing and dance and it don’t walk… Neil Diamond Economics is not really about money. We measure value and cost in units of money, but continually have to adjust such measures for inflation. If you drop a $50 bill and the wind blows it away, there is no social loss or social cost – unless you run after it! If you do, you have expended energy keep the $50 (so you can buy something with it). If you don’t, either someone else will find it (simple transfer of value from you to her) or it gets lost forever. If it is lost forever, the food, clothing, or trinkets you would have bought still get bought by someone, perhaps at infinitesimally smaller prices because there is slightly less money in the economy. A corollary is that services like health care are not “free” just because you don’t pay for them. Please try very hard not to confuse cost with price . The price of a visit to the doctor’s office (what you pay) may be zero or a $10 co-pay, but the cost (nurse, doctor, and clerical time; materials, tests, etc.) is much higher. The prices of prescription drugs may be as high as $100 a pill, but the cost of producing that pill is surely much lower, perhaps negligible. Because of insurance coverage (doctor visit) or monopoly power (drug patents), the connection between cost and price may be remote. In an ideal system, in which prices are determined by competitive market forces, prices reflect costs very well – but more on that later. Economics is about the logic of scarcity and choice. It is definitely concerned with prices and costs, but less concerned with absolute (dollar) amounts than with relative amounts. To isolate some basic principles, imagine that labor is the only scarce resource and that it can be used to produce food or clothing. A worker can produce either 5 pizzas or 10 T-shirts per day and the labor supply is 100 workers. Notice that the scarcity of labor limits food production to 500 pizzas per day. Moreover, if anyone wants clothing, pizzas have to be sacrificed. Specifically: a shirt costs half as much (labor) as a pizza, but more importantly, the opportunity cost of a pizza is two shirts.
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This note was uploaded on 05/09/2008 for the course ECN 212 taught by Professor Nancy during the Fall '07 term at ASU.

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01. Opportunity Cost - Opportunity Cost Money talks, but it...

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