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KWCh_07_Opportunity_Cost_and_Decisions - chapter 7 > Making...

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>> Making Decisions Section 1: Opportunity Cost and Decisions chapter 7 In Chapter 1 we introduced some core principles underlying economic decisions. We’ve just seen two of those principles at work in our tale of two invasions. The first is that resources are scarce —the invading Allies had a limited number of landing craft, and the invading Germans had a limited number of divisions. Because resources are scarce, the true cost of anything is its opportunity cost —that is, the real cost of some- thing is what you must give up to get it. When it comes to making decisions, it is cru- cial to think in terms of opportunity cost, because the opportunity cost of an action is often considerably more than the simple monetary cost. Explicit Versus Implicit Costs Suppose that, after graduating from college, you have two options: to go to school for an additional year to get an advanced degree or to take a job immediately. You would like to take the extra year in school but are concerned about the cost. But what exactly is the cost of that additional year of school? Here is where it is important to remember the concept of opportunity cost: the cost of that year spent getting an advanced degree is what you forgo by not taking a job for that year.
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This cost, like any cost, can be broken into two parts: the explicit costs of the year’s schooling and the implicit costs . An explicit cost is a cost that requires an outlay of money. For example, the explicit cost of the additional year of schooling includes tuition. An implicit cost, on the other hand, does not involve an outlay of money; instead, it is measured by the value, in dollar terms, of all the benefits that are forgone. For example, the implicit cost of the year spent in school includes the income you would have earned if you had taken that job instead. A common mistake, both in economic analysis and in real business situations, is to ignore implicit costs and focus exclusively on explicit costs. But often the implicit cost of an activity is quite substantial—indeed, sometimes it is much larger than the explicit cost. Table 7-1 gives a breakdown of hypothetical explicit and implicit costs associated with spending an additional year in school instead of taking a job. Explicit costs con- sist of tuition, books, supplies, and a home computer for doing assignments—all of which require you to spend money. Implicit costs are the salary you would have
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KWCh_07_Opportunity_Cost_and_Decisions - chapter 7 > Making...

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