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CHAPTER 2 - SOME TOOLS OF THE ECONOMIST See opening quote, Friedman, page 27. Choice involves the loss of foregone alternatives. OPPORTUNITY COST is the highest valued alternative that must be sacrificed when one chooses. (Choosing between A and B, if you choose A the OPP COST of A is B). Costs are always subjective and exist in the mind of the decision maker. Costs and benefits are highly individual, and can only really be evaluated with 100% accuracy by the decision maker. Costs being subjective allows trade to take place and re-allocates goods to the people who value them most highly. Example - classified ads for used goods. Cost usually has a MONETARY cost and a NON-MONETARY cost. Think of the TOTAL COST of getting a college degree. What is the largest cost of a B.A. degree? Example - Greyhound bus to Miami for $50 each way. 2-3 days on the road each way is a non- monetary cost. Explains why Bill Gates/Oprah/Michael Jordan don't take the Greyhound bus - they have a very high OPP COST in terms of the next highest valued alternative. Their time is very expensive/valuable. Unemployed person, or a college student would be more likely to take the bus, they have a lower opp. cost in terms of the sacrificed alternatives. Their time is not worth as much. Example: Round trip airline ticket costs $150 and a bus ticket costs $110. Bus - 10 hours, Airplane - 2 hours. Bus is 8 hours longer and $40 cheaper, or a savings of $5/hour. If the opp. cost of your time is less than $5, you should take the bus. If the opp. cost of your time is greater than $5, you should fly. Example: Labor market. The cost of hiring someone if the opp. cost of the next highest paying job available. If you want to hire a lawyer to teach or be a Univ. administrator, you will have to compensate them for the next highest valued alternative - private law practice. Variation in college professors' salaries reflect OPP COST. Or, a Univ. professor can either teach during the summer or work doing consulting project. To do the consulting project, they have to be paid at least as much as summer teaching. Employers have to bid away workers from other employment opportunities. Example - retirees watch more daytime TV than working professionals. Why? It is more costly for a stockbroker or real estate agent to take time away from work during the day to watch TV. Retirees have a low opp. cost. Example - the opp. cost of taking time off from studying to go to the movies is higher during exam time. Study time becomes more valuable during exam time and recreation time is more costly. Choosing recreation would be much more costly during exam time than the first week of the semester. TRADE CREATES VALUE MGT 551: BUSINESS ECONOMICS - CH 2 Professor Mark J. Perry 1
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Voluntary Trade and exchange create economic value and increase wealth and prosperity because: 1. Trade is WIN-WIN. What people gain in an exchange is worth more to them to what they give up.
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