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๐Ÿ’ธย  Unit 1: Basic Economic Concepts

1.5 Cost-Benefit Analysis

#marginalcost

#marginalrevenue

#marginalbenefit

#implicitcost

#explicitcost

โฑ๏ธย ย 3 min read

written by

jeanne stansak

September 17, 2020


In economics, consumers make rational choices by weighing the costs and benefits. In economics, marginal means additional, or the change in the total (you will see this term a lot!)

Two Types of Costs

  • Explicit Costsโ€”traditional out of pocket costs associated with choosing one course of action. For example, the explicit cost of going to college is the paying of college tuition.
  • Implicit Costsโ€”monetary or non-monetary opportunity costs of making a choice. For example, the implicit costs of going to college are forgone wages you can't earn when you go to college full-time, or the traveling you can't do because you are in school.

Marginal Benefit vs. Marginal Cost

  • Marginal Benefitโ€”the benefit from consuming an additional unit of a good or service. For the most part, marginal benefit decreases as you consume more and more.
  • Marginal Costโ€”the cost of consuming an additional unit of a good or service. Marginal cost usually increases as you consume more and more.

The general rule in economics is to consume where marginal benefit = marginal cost, also known as the benefit maximizing quantity.

Sample Questions

Question 1

After graduating high school, Billy decided to enroll in a two-year program at the local community college rather than to accept an internship that offered a salary of $15,000 per year. If the annual tuition and fees are $5,000, the annual opportunity cost of attending the community college is:

Answer

$20,000

Explanation

Opportunity cost includes both explicit and implicit costs. In this question, the $15,000 in salary for the internship you gave up is the implicit cost, and the $5,000 in tuition and fees is the explicit cost of going to the community college.

Question 2

All of the following are included in computing the opportunity cost of attending college EXCEPT:

(A) interest paid on student loans

(B) wages the student gave up to attend college

(C) money spent on books and supplies

(D) money spent on college tuition

(E) money spent on clothing expenses

Answer

Choice E

Explanation

No matter what decision you make, you will always have clothing expenses

Question 3

Sylvia works part-time at a local convenience store and earns $12 per hour. She wants to spend next Saturday afternoon attending a sporting event. The full price of the sporting event is $100, but Sylvia was able to get a discounted price of $75 from her cousin who purchased the ticket and is unable to attend. If Sylvia took 5 hours off from her job to attend the sporting event, what was her opportunity cost of attending the concert?

Answer

$135

Explanation

Sylvia would have earned $60 from working for 5 hours (implicit cost). She also spent $75 on the ticket (explicit cost). 60 + 75 = 135.

Question 4

Janeโ€™s marginal benefit per day from drinking Pepsi is given in the table below. The table shows that she values the first Pepsi she drinks at $1.25, the second at $1.20, and so on. If the price of a Pepsi is $1.00, how many should Jane drink?

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Answer

3 Pepsis

Explanation

The optimal number of Pepsis that Jane should drink is 3 because that is where marginal cost ($1.00, the price of a Pepsi) is equal to the marginal benefit of the 3rd Pepsi.

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