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Understanding Opportunity Costs and Trade-Offs in Decision Making

This chapter explores the concept of opportunity costs and trade-offs involved in decision-making. It discusses how every choice, whether by individuals, businesses, or societies, comes with alternatives that must be sacrificed. Through the decision-making grid, readers can evaluate the benefits and costs of each option, exemplified by Karen's analysis of sleeping late versus waking up early to study. The importance of recognizing opportunity costs in daily choices emphasizes the impact of scarcity and the need for careful consideration in resource allocation.

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Understanding Opportunity Costs and Trade-Offs in Decision Making

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  1. Chapter 1 Section 2: Opportunity Costs

  2. Trade offs • Alternatives that we give up whenever we choose one course of action over another • Individuals & trade offs • Every decision involves a trade off

  3. Businesses & trade offs • Decisions that business people make about how to use land, labor, & capital resources also creates trade offs

  4. Society & trade offs • Guns or butter • A country that decides to produce more military goods has fewer resources to devote to consumer goods & vice versa

  5. Defining Opportunity Cost • Most desirable alternative given up as a result of a decision • Every ordinary decision that we make everyday involves an opportunity cost

  6. Using a decision making grid • Can help you determine whether you are willing to accept the opportunity cost of a choice you are about to make

  7. Karen’s Decision-making Grid Alternatives Sleep late Wake up early to study Benefits • Enjoy more sleep • Have more energy during the day • Better grade on test • Teacher and parental approval • Personal satisfaction Decision • Sleep late • Wake up early to study for test Opportunity cost • Extra study time • Extra sleep time Benefits forgone • Better grade on test • Teacher and parental approval • Personal satisfaction • Enjoy more sleep • Have more energy during the day • Economists encourage us to consider the benefits and costs of our decisions.

  8. Making the decision • With each new situation, the opportunity costs & benefits change • We always face opportunity costs • When we select one alternative, we have to sacrifice at least one alternative & forgo its benefits • By recognizing what we are sacrificing, we can decide whether the decision is worth it

  9. Opportunity Cost: the foregone alternative Think: “next-best”

  10. What’s scarce when you’re in the Mall of America? at the all-you-can-eat buffet? Scarcity IS: Even in the face of abundance . . .

  11. Opportunity Cost Analysis What was the 1st decision you made this morning?

  12. Opportunity Cost Analysis Decision Maker: YOU

  13. Opportunity Cost Analysis Decision Maker: YOU More sleep

  14. Opportunity Cost Analysis Decision Maker: YOU More sleep X

  15. Opportunity Cost Analysis Decision Maker: YOU

  16. Thinking at the Margin • Many decisions involve adding one unit or subtracting one unit

  17. Making a decision at the margin • When you decide how much more or less to do, you are thinking at the margin.

  18. Cost & benefit at the margin • Such a comparison could help someone decide how much money to spend on a car, how many hours to work, & how much time to spend watching TV

  19. Cost/Benefit Analysis • Decision makers just have to compare the opportunity costs & the benefits • What they will sacrifice & what they will gain • Once the opportunity cost outweighs the benefits, no more units should be added

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