To truly consider costs we must always consider our opportunity costs which include the implicit and explicit costs of an action. This isn’t meant to scare you, but rather to emphasize that a rational consumer doesn’t ignore time, but incorporates it into the analysis of any decision they make. This leads us to a fairly simple conclusion. The opportunity cost of the new product design is increased cost and inability to compete on price. Notice that the $60 is not included as an explicit costs because it is not an additional cost we have to incur as a result of working out. The opportunity cost of producing 60 Umies instead of 30 Umies is: A. If you have gone clubbing, this is likely close to what you paid for it. As decision makers, we have to make trade-offs on what we do with finite resources. a) I, II and III. The key difference is that risk compares the actual performance of an investment against the projected performance of the same investment, while opportunity cost compares the actual performance of an investment against the actual performance of a different investment. If we took them all into account our costs would be infinite. Assume you also work as a server at the campus pub, where you get paid $15 an hour (including tips). 20 mugs. b. Which of the following statements about sunk costs is FALSE? In this example if you were to go clubbing opportunity costs are: Explicit Costs (cover, drinks and ride home) : $50, Implicit Costs (forgone income from 5 hours) : $75. Assuming that it is impossible to resell the Lady Gaga ticket, what is the minimum value you would have to place on a night at the opera, in order for you to choose the opera over Lady Gaga? d) All of the above were relevant. The economic, or opportunity, cost of doing accounting work is measured by computing the monetary amount that the owner’s time would be worth in its next best use. Also, the total opportunity cost of producing 5 computers, is equal to the individual opportunity cost (or marginal costs) added up. B. Consider the case of an investor who, at the age of 18, was encouraged by their parents to always put 100% of their disposable income into bonds. Cars: 10. Abilities vs Abilities The opportunity cost of after school violin lessons at a particular school is the ability to join other after school activities such as baseball or the chess club. c. What is Angela's opportunity cost of 1 mug? I. Sunk costs are those that cannot be recovered, no matter what future action is taken. Opportunity Cost of Production. We can lay the process out in three steps: If we want to change this into the process for a binary decision (yes or no): It is important to note that not all decisions are binary. Say that you have option A: to invest in the stock market hoping to generate capital gain returns. The opportunity cost of running the hardware store is $550,000,consisting of $500,000 to rent the store and buy the stock and a $50,000implicit cost, because your aunt would quit her job as an accountant to run thestore. Simple – what else could we be doing with that time? This is very simple. Types of opportunity costs Explicit costs. Consider the two options you may have when you wake up – do you work out or sleep in? Thus, while 1,000 shares in company A might eventually sell for $12 a share, netting a profit of $2,000, during the same period, company B increased in value from $10 a share to $15. What Is The Opportunity Cost Of The First 20 TV Sets? Ever heard the expression “we’ve invested too much in this project to back out now?” Even if you have not, it sounds fairly logical – unfortunately it is not. As such it should have no impact on future decision making. Opportunity cost is a very important concept in economics, but it is often overlooked by investors. shirt in America costs 1/100 worker-years (1 worker working for 1 year), and freeing up the necessary 1/100 worker-years in America would mean (1/100 * 20) = 0.2 fewer computers produced. Suppose that you are willing to pay $50 to see a movie on Saturday night. What is vinny's opportunity cost of producing a t-shirt? For 5 hours of clubbing, you are forgoing the opportunity to earn $75 ($15 * 5). First Year $250 (half of $500) x 20% = $50 expense claim. What do your sunk costs equal? Country 2. Both options may have expected returns of 5%, but the U.S. Government backs the rate of return of the T-bill, while there is no such guarantee in the stock market. In other words, by investing in the business, you would forgo the opportunity to earn a higher return. Well in this case, it might be a bad idea. Let’s say that for a 5 hour night at the club, the MOST you are willing to pay is $100. a. The conclusion: Sunk costs are irrelevant for decision making. If that was the case you would need to find a way to increase your willingness to go to the gym, for example, if you committed to a work out plan with a friend, the social cost of sleeping in may be high, incentivizing you to get out of bed. 1983 >Notable computer: Apple Lisa >Price tag: $9,995 >Inflation adjusted price: $23,794 The Apple Lisa was one of the first commercially available personal computers with … Creative Commons Attribution 4.0 International License, Understand the three step process for making binary decisions, Calculate the opportunity cost of an action, Understand how sunk costs influence our decision making, Find your willingness to pay (or wage you would earn) from the option you are considering and the next best alternative, Subtract the explicit costs from each option to find your happiness, Choose the option with that makes you happier, If benefits > costs, this is the right choice. Opportunity cost of 1 computer 10 tons of 100 slope. In economics, risk describes the possibility that an investment's actual and projected returns are different and that the investor loses some or all of the principal. Why would one ever buy a gym membership? The opportunity cost of something is whatmust be given up to acquire it. C) $80. In a typical month I spend about $50 on beer at the Club. When assessing the potential profitability of various investments, businesses look for the option that is likely to yield the greatest return. Indeed, it is unavoidable. It is important to note that the implicit costs are the benefit of the next best option. While the opportunity cost of either option is 0 percent, the T-bill is the safer bet when you consider the relative risk of each investment. c) II only. The opportunity cost of doing accounting work is the time not spent in other ways, i.e., time such as running a small business or participating in leisure activity. 1. Daniel Bernoulli, an economist, first introduced the concept of utility as a means of measuring happiness. 1. Funds used to make payments on loans, for example, cannot be invested in stocks or bonds, which offer the potential for investment income. The $75 we could be earning from working is equal to our implicit costs of going out since, rather than going clubbing, we could be making money for the 5 hours. Since we have already paid the $60, it is no longer something we consider. If the opportunity cost of producing one car in Japan is 10 computers and the opportunity cost of producing one car in the United States is 5 computers, then the United States has a comparative advantage in computer production. This may sound strange, but consider the your two options using the analysis learned above for making decisions. But what about our time? The opportunity cost of doing accounting work is the time not spent in other ways, i.e., time such as running a small business or participating in leisure activity. If I don’t loan my brother the $10,000, it will stay in my bank account for the year, where it will earn 2% interest. Tickets cost $100, and the next-best alternative use of your time would be to work in paid employment earning $50 over the evening. How do we measure time? If the opportunity cost of producing one car in Japan is 10 computers and the opportunity cost of producing one car in the United States is 5 computers, then the United States has a comparative advantage in computer production. Because by definition they are unseen, opportunity costs can be easily overlooked if one is not careful. What we are less good at considering is scarcity of time. The opportunity cost of moving from a to b is… Hi-Tech Inc. has several outdated computers that cost a total of $8,900 and could be sold as scrap for $2,300. If Hi-Tech updates the computers and sells them, net income will increase by $4,500. So in this example we are moving from combination H to combination C (but the way the table is created we stop at D). Opportunity cost accounts for alternative uses of resources such as time and money. He has agreed to pay 10% interest on the loan. Answer: 1/2 pot. Country 1 can produce either 10 cars or 20 computers whereas Country 2 can produce 22 cars or 30 computers with available resources. D) The economy cannot move to point A. An explicit cost represents a clear direct payment of cash (whether actual cash or from debit, credit, etc). Opportunity cost of 1 computer 10 tons of 100 slope 10 Active. Suppose that you deciding between seeing a move and going to a concert on a particular Saturday evening. 2. D) Unable to determine without knowing input costs. Which of the following was relevant to this decision? Expert Answer 100% (1 rating) Previous question Next question Transcribed Image Text from this Question. 15. 8. They could be updated for an additional $1,200 and sold. Product: Country 1: Country 2: 1 Unit of Computer: 0.5 Unit of Car. For more information from our reviewer on calculating opportunity cost, including how to evaluate non-financial resources, read on! How to Calculate Present Value, and Why Investors Need to Know It. III. A rational consumer would chose to work. 5.What can you say about point G? 2. Topic 1: Introductory Concepts and Models. A sunk cost is a cost that no matter what is unrecoverable. The current mine site will cost $1 million to extract the remaining resources ($4 million projected revenue). If, for example, a company pursues a particular business strategy without first considering the merits of alternative strategies available to them, they might therefore fail to appreciate their opportunity costs. This makes it easy to put a dollar amount on your time. Opportunity cost is equal to implicit costs plus explicit costs. 0.71 cups of ice cream. The opportunity cost of going to the movie is: 4. Some would argue that opportunity cost is not a “real” cost because it does not show up directly on a company’s financial statements. However, businesses must also consider the opportunity cost of each option. Suppose that you are willing to pay $350 to see Leonard Cohen play at the Save-On-Foods Arena. Opportunity Cost BK-CEE-ECONOMICS-131302.indb 1 13-06-2014 03:23:20. And if it fails, then the opportunity cost of going with option B will be salient. Although this result might seem impressive, it is less so when one considers the investor’s opportunity cost. The opportunity cost of running the hardware store is $550,000,consisting of $500,000 to rent the store and buy the stock and a $50,000implicit cost, because your aunt would quit her job as an accountant to run thestore. b. Opportunity cost concerns the possibility that the returns of a chosen investment are lower than the returns of a forgone investment. Opportunity cost of 1 computer = 10 tons of wheat. The company must decide if the expansion made by the leveraging power of debt will generate greater profits than it could make through investments. ½ CD per article. If investment A is risky but has an ROI of 25% while investment B is far less risky but only has an ROI of 5%, even though investment A may succeed, it may not. Suppose you have bought and paid for a ticket to see Kanye in concert. Buying 1,000 shares of company A at $10 a share, for instance, represents a sunk cost of $10,000. Skill: Analytic AACSB: Analytic Skills 10) The concept of opportunity cost can be applied to the analysis of _____ decision-making Nevertheless, because opportunity cost is a relatively abstract concept, many companies, executives, and investors fail to account for it in their everyday decision-making. c) The fact that I also had to write a 103 midterm exam today. Opportunity costs only measure direct out of pocket expenditures. a) The $40 that I paid the gym this month. tshirts; ice cream. Second Year $450 x 20% = $90 expense claim. Seem high? In this scenario, investing $10,000 in company A returned $2,000, while the same amount invested in company B would have returned a larger $5,000. The ‘willingness to pay’ represents how badly someone might want to go to the gym. What is Angela's opportunity cost of 1 pot? Have you ever convinced yourself to get out of bed by reminding yourself that you paid $60 for your monthly gym membership? Given the production possibility curve, the opportunity cost of reading 2 more articles when you are already reading 11 articles is on average: A. that the additional pieces you need will cost you $20 more. Suppose the costs of going clubbing are $50 ($15 cover, $20 for drinks and $15 for a ride home). Question: 10 20 30 40 50 60 70 80 90 100 Computers Es B. 11. C. 30 Ums. b) I Opportunity cost analysis also plays a crucial role in determining a business's capital structure. We must consider time as another cost of the action. Overview: Opportunity Cost : Type: Decision Making. A ticket costs $10, and the next-best alternative use of your time would be to go to dinner with a friend. 4.The opportunity cost of moving from f to c is… 3.The opportunity cost of moving from d to b is… 7 Bikes. Answer: 2 mugs. I. Often, people don't think about the things they must give up when they make those decisions. I am considering loaning my brother $10,000 for one year. Therefore, the opportunity cost is the difference in value lost from producing a smartphone rather than a computer. D. 3 CDs per article. Although the company’s chosen strategy might turn out to be the best one available, it is also possible that they could have done even better had they chosen another path. If a textile worker earns 38,000 per year working in a textile mill on a job that was saved by a protective tariff costing consumers 148,000 per year ( for that job alone) the textile worker could be paid 48,000 to stay home all day watching TV when the protective tariff is eliminated and consumers would still be better off by approximately Suppose you play a round of golf costing $75. Following our steps we find the maximum willingness to pay for each option, subtract the explicit costs, and compare the happiness from each. The economic, or opportunity, cost of doing accounting work is measured by computing the monetary amount that the owner’s time would be worth in its next best use. This morning, I was trying to decide whether or not to actually go to the gym. Production Possibilities and oPPortunity cost Lesson 1 Opportunity Cost To an economist, the true cost of anything is more than the monetary price (the “price tag”) of the good or service. Again, an opportunity cost describes the returns that one could have earned if he or she invested the money in another instrument. What is the opportunity cost of one basketball in terms of soccer balls when moving from point B to point C? What should the company do? When a business must decide among alternate options, they will choose the one that provides them the greatest return. II. Economists focus on the true cost as the op-portunity cost. An opportunity cost would be to consider the forgone returns possibly earned elsewhere when you buy a piece of heavy equipment with an expected return on investment (ROI) of 5% vs. one with an ROI of 4%. Society’s wants are unlimited, but ALL resources are limited (scarcity). A) 25 computers. Refer to the graph shown. Discounted cash flow (DCF) is a valuation method used to estimate the attractiveness of an investment opportunity. Which of the following statements about opportunity cost is TRUE? There are an infinite number of things we could be doing with our time, from watching a movie to studying economics, but for implicit costs we only consider the next best. Normally we are quite good at considering scarcity when it comes to resources and money. I also spent $300 on extremely stylish gym clothes. Also, the total opportunity cost of producing 5 computers, is equal to the individual opportunity cost (or marginal costs) added up. As an investor, opportunity cost means that your Therefore the relevant opportunity cost is 0.2 computers. But there they are—fully countable—staring you in the face. II. The opportunity cost of seeing Leonard Cohen is equal to: 9. For the Internet opportunity, she anticipates costs for land, labor, and capital of $3,250,000 per year as compared to revenues of $3,275,000 per year. 1 Unit of Car: 2 Unit of Computer. Option B, on the other hand is: to reinvest your money back into the business, expecting that newer equipment will increase production efficiency, leading to lower operational expenses and a higher profit margin. Given this, what do my monthly SUNK COSTS equal? 3) Jane produces only corn, measured in tons, and cloth, measured in bolts. D. 40 Ums. By the end of this section, you will be able to: Economics looks at how rational individuals make decisions. 20 Ums. 3. As a member of UVic’s University Club, I pay $30 per month in membership fees. d) None of the statements is true. The idea of opportunity costs is a major concept in economics. While financial reports do not show opportunity costs, business owners often use the concept to make educated decisions when they have multiple options before them. The important lesson here is to be mindful of your future motivation when you are incurring a sunk cost. Opportunity cost is the value of something when a particular course of action is chosen. 5 Key Economic Assumptions. 10 pots? The opportunity cost of a given action is equal to the value foregone of all feasible alternative actions. Having takeout for lunch occasionally can be a wise decision, especially if it gets you out of the office for a much-needed break. B. As economists, we want to measure the happiness you will get from this experience by finding your maximum willingness to pay. A firm tries to weight the costs and benefits of issuing debt and stock, including both monetary and non-monetary considerations, in order to arrive at an optimal balance that minimizes opportunity costs. It is equally possible that, had the company chosen new equipment, there would be no effect on production efficiency, and profits would remain stable. Let us now do the same Opportunity Cost example in Excel. For her, the opportunity cost of one more ton of corn is A) the ratio of all the bolts of cloth she produces to all the tons of corn she produces. So the opportunity cost of buying an SUV includes an alternative option, such as buying a less expensive sedan. Unattainable. Because opportunity cost is a forward-looking consideration, the actual rate of return for both options is unknown today, making this evaluation in practice tricky. Daniel Bernoulli, an economist, first introduced the concept of ... With this willingness to pay reflected in the table, the better option is to Sleep-In, with an opportunity cost of $20. The opportunity cost of choosing this option is then 12% rather than the expected 2%. The golf takes four hours to play. The benefit or value that was given up can refer to decisions in your personal life, in a company, in the economy, in the environment, or on a governmental level. In reality, it is must harder to measure the happiness a consumer  receives from a good. d) I and III only. 1. 30. Abilities vs Abilities The opportunity cost of after school violin lessons at a particular school is the ability to join other after school activities such as baseball or the chess club. If they're cautious about a purchase, many people just look at their savings account and check their balance before spending money. If the selected securities decrease in value, the company could end up losing money rather than enjoying the expected 12 percent return. 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