Transcript Lesson 2: Opportunity Cost & Incentives

I have with me at this EFL program a new Dell Vostro 13 Notebook computer.
It has 13” screen, DVD drive, 500 GB hard drive, 4 GB Ram, i5 processor,
windows 7, internal wireless, etc.
Questions:
It is mine. How much money would you give me for the computer? (You have
until the end of the week to come up with the cash)
________
I have applied for a grant to study cigarette tax policies across the different
states of the United States. To perform this project punctually, I will probably
have to hire some research assistants. This work will have to be performed
during the next 30 days. (at your home) The work will include data collection,
research, and data coding.
Questions:
2.How many hours would you work total over that time period?
(next 30 days) if I paid you $35 per hour
3. I will probably undertake the project even if I do not get the
grant. How many hours would you be willing to work if I
paid you $10 per hour?
Economics for Leaders
Economics for Leaders
Lesson 2: Opportunity
Cost & Incentives
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Economic Reasoning Principle #1:
People choose, and individual choices are
the source of social outcomes.
Scarcity necessitates choices
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How Do You Know When
Something Is
Scarce?
Scarcity Forces You to
CHOOSE
SCARCITY
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CHOICE
Economic Reasoning Principle # 2:
Choices impose costs; people receive
benefits and incur costs when they make
decisions.
The cost of a choice is the value of the next-best
alternative foregone.
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Opportunity Cost:
the value of the next best or
foregone alternative
Think: “next-best”
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Opportunity Cost =the value of
the
Next-Best Alternative
– What are the considered alternatives?
• What would you do – not what could you do?
• What does the decision-maker perceive to be
the benefits of each alternative?
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Opportunity Cost Analysis
What was the 1st decision you
made this morning?
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Opportunity Cost Analysis
Decision Maker: YOU
Alternatives:
Perceived
Benefits
Choice
Opp. Cost
Benefits
Refused
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Get Up Now
Don’t Get Up
Now
Opportunity Cost Analysis
Decision Maker: YOU
Alternatives:
Perceived
Benefits
Choice
Opp. Cost
Benefits
Refused
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Get Up Now
Shower
bkfst
don’t rush
On time coffee
Don’t Get Up
Now
More sleep
Opportunity Cost Analysis
Decision Maker: YOU
Alternatives:
Perceived
Benefits
Choice
Opp. Cost
Benefits
Refused
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Get Up Now
Shower
bkfst
don’t rush
On time coffee
Don’t Get Up
Now
More sleep
X
X
Choosing is Refusing
Every time we choose we pay a cost.
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People’s Choices are always
RATIONAL
Rational choice = choosing the
alternative that has the greatest excess
of benefits over costs.
If ALL choices are rational, then the
challenge is to understand the decisionmaker’s perception of costs and benefits.
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Characteristics of Cost
Costs are the results of ACTIONS
Costs are TO people; things have no cost
All costs lie in the FUTURE (past costs
are “sunk” costs)
Costs are frequently not monetary
(although we may value them in dollar
terms)
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What Determines Your
Opportunity Cost?
Alternatives
Tastes and preferences (values)
Rules of the Game--Institutions
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Do Gov’t actions have
opportunity costs?
Government Debt
Economic Stimulus Package
War in Iraq
Limiting Carbon Emissions
Universal Healthcare
All alternatives have cost and benefits
Individuals perceive the value of costs and benefits
differently
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Back to Scarcity: What’s the Question?
(And what does opportunity cost have to
do with it?)
Should we
Allocate?
ration?
Given that we MUST ration, what is
the best mechanism?
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Allocating/Rationing DVDs
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Methods of Rationing Scarce
Goods and Services
prices
command (someone
decides)
majority rule
contests
by force
voting
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first-come-firstserved
sharing equally
lottery
personal
characteristics
need or merit
Why is price rationing the most
common method of allocating scarce
goods, services, and resources in our
economy?
1. The outcome is clear
2. Individuals can affect the outcome based on
their desire for the product
3. It directs resources to their most highly valued
uses
4. Individuals’ power and freedom is enhanced
5. It provides incentives for both consumers and
producers to reduce scarcity.
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Where do Prices Come From?
The market interaction of buyers and
sellers in open and competitive
markets!
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Prices: POWERFUL Incentives
When prices change, opportunity costs change –
that’s an incentive!
Both consumers and producers react to prices in
ways that help us to deal with scarcity.
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Economic Reasoning Principle # 3:
People respond to incentives in
predictable ways.
Choices are influenced by incentives, the rewards
that encourage and the punishments that
discourage actions. When incentives change,
behavior changes in predictable ways.
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When incentives (Prices) change,
behavior changes in predictable
ways.
When prices go up consumers demand a
larger/smaller quantity?
Demand
The willingness and ability to purchase goods and
services at various prices.
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When incentives (Prices) change,
behavior changes in predictable
ways.
When prices go up consumers demand a
larger/smaller quantity?
Smaller
When prices go down consumers demand
a larger/smaller quantity?
Larger
Always?
Law of Demand P Q
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When incentives (Prices) change,
behavior changes in predictable
ways.
When prices go up producers supply a
larger/smaller quantity?
Supply
Producers willingness and ability to produce
goods and services at various prices.
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When incentives (Prices) change,
behavior changes in predictable
ways.
When prices go up producers supply a
larger/smaller quantity?
Larger
When prices go down producers supply a
larger/smaller quantity?
Smaller
Always?
Law of Supply P Q
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What does Opportunity Cost have
to do with supply and demand?
Everything!
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Choices are made at the
Margin
Our only choice is the next choice
Marginal = additional, next, a little more
or a little less
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How much should we do?
Work
Play
Study
Sleep
Buy
Sell
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As long as the marginal
benefit is greater than the
marginal cost you should
continue the activity
MB=MC
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The “Big Ideas” from Lesson
2:
1. Scarcity forces us to choose and every choice
has an opportunity cost.
2. When opportunity costs change, incentives
change, and choices change.
3. Because costs lie in the future, the important
costs and benefits occur at the margin.
4. Money price rations goods in markets.
5. Consumers and producers respond to changes
in price in predictable ways.
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