1. ECON 100 Lecture 3
Monday, September 22

2. Announcements
Course webpage
Class participation records are posted.
the Announcements section
Problem set #1 will be posted later this week.
the Assignments section
Problem sets (study questions) are an important resource for preparing for the exams.

3. of last week’s lectures
A short summary
of last week’s lectures

4. Economists assume that…
people are rational and behave according the following rule: “Take an action if and only if the benefits exceed costs.” Do activity x if B(x) ≥ C(x)

5. The Cost-Benefit Principle
Measuring the costs and benefits of an action is not always very easy.
Stem-cell research
Missile defense system
Career choice
Auto purchase

6. What are the problems?
People sometimes ignore costs that should be counted.
Opportunity cost
People sometimes count costs that should be ignored.
Sunk cost
More on this second “problem” later in the lecture.

7. Do not ignore the opportunity costs
Making a rational decision requires the recognition of opportunity cost.
Opportunity cost of an action is the net benefit of the next-best alternative.

8. from Wednesday’s lecture last week
Clapton vs. Dylan
from Wednesday’s lecture last week

9. The question You have a free ticket to Clapton.
Same night there is also a Dylan concert.
Dylan is worth to you $50.
Dylan tickets cost $40.
What is the opportunity cost of seeing Clapton?
A. $0 B.$10 C. $40 D. $50

10. How did Econ100 students do?
Exceedingly well!

11. Results (2 sections combined)
answer
# of students
% of students $0 3
2,2%
$10
130
95,6%
$40 2
1,5%
$50 1
0,7%

12. ANSWER: “B” $10 ( = 50 – 40) .

13. Why is B $10 the correct answer?
When you choose Clapton, you give up the net benefit of Dylan, which is your enjoyment (measured at $50) minus the ticket cost, which is $40. The net benefit of the Dylan concert is ($50–$40=) $10. This ($10) is what you give up if you choose Clapton. One more time… What is the opportunity cost of seeing Clapton? It is the net benefit of the alternative.

14. Paul Ferraro and Laura Taylor, asked this very same question,
which is taken from page 4 of Robert Frank and Ben Bernanke’s textbook, Introduction to Microeconomics,
to PhD students and professors at the ASSA meeting, in 2005.
ASSA: Allied Social Science Associations meeting organized by the American Economic Association

15. This is an opinion piece by Robert Frank
Their findings were mentioned in the New York Times
The Dismal Science, Dismally Taught - New York Times
Paul Ferraro and Laura Taylor, “Do Economists Recognize an Opportunity Cost When They See One? A Dismal Performance from the Dismal Science.”

16. How did the PhD students and professors answer this question?
Respondents spent, on average, close to five minutes answering the survey. $0
25.1%
$10
21.6%
$40
25.6%
$50
27.6%

17. Let’s also see the second and more “difficult” opportunity cost question. Because, as Prof Robert Frank says, “[…] the opportunity cost concept, so central to our understanding of what it means to think like an economist, is but one among hundreds of concepts that go by in a blur.”

18. A difficult opportunity cost question #1
You have a free ticket to a Eric Clapton concert which you can sell for $35. Bob Dylan is performing on the same night and is your next-best alternative activity.
Tickets to see Dylan cost $40.
Dylan is worth to you $50.
There are no other costs of seeing either performer.
What is the opportunity cost of seeing Clapton?
It is $45!

19. Suggested solution; a difficult opportunity cost question #1
The opportunity cost of Clapton is what you give up if you go to see Clapton. Oppoturnity cost of Clapton is $10 + $35 = $45 Why? $10 (=$50 – $40) is the net benefit of Dylan $35 because you give up the opportunity to earn $35 (you are using the Clapton ticket yourself rather then selling it for $35)

20. A “what would you do”-question

21. A. You can buy a computer game for $25 at the campus store or go down-town (Sarıyer) to buy it from a store selling it for $15. Where would you buy the game? In your opinion where would most people buy the game?

22. B. Would you go downtown (Sarıyer) to save $10 on a $2020 laptop (sold in the campus IT store)? In your opinion what would most people do in this situation?

23. The scarcity principle
The opportunity cost
(fırsat maliyeti)

24. There is no such thing as a free lunch!

25. Herşeyin bir bedeli var!

26. There is no such thing as a free lunch!
“Although we have boundless needs and wants the resources available to us are limited. As a consequence, having more of one good necessarily means having less of another.” Consider the following statement: “The citizens of Sweden are lucky because they have free health care while the citizens of the US have to pay for it.”

27. Our very first economic model
The production possibilities frontier
(PPF)
Üretim İmkanları Eğrisi

28. Economic Models
Economists use models to simplify reality in order to improve our understanding of the world. One such model (one of the earliest and most widely used) is David Ricardo’s model of comparative advantage, which we will see next week.

29. Economic Models
In constructing their models economists make many simplifying assumptions. David Ricardo’s model has two countries: England and Portugal, and each country produces two goods: wine and cloth.

30. Economic Models
A simple model: The Production Possibilities Frontier

31. The Production Possibility Frontier is...
a graph that shows the combinations of goods (and services) that the economy can produce given the available resources (labor force, capital goods) and existing technology.

32. The scarcity principle means that people (countries) face trade offs.
Imagine a country that produces only cars and computers

33. A country produces only cars and computers.
Quantity of computers produced
PPF shows the combinations of goods the country can produce given the available resources and existing technology
3,000  D C
2,200
600 A
700
2,000
Production
Possibilities
Frontier
1,000
300 B 
1,000
Quantity of cars produced

34.  Quantity of Computers Produced 3,000  D C 2,200 600 A 700 2,000
Producing at a point like B means that either some resources are kept idle, or the resource are not allocated efficiently.
Computers
Produced
Points outside the PPF (like D) are not attainable with available resources and technology.
3,000  D C
2,200
600 A
700
2,000
Production
Possibilities
Frontier
1,000
300 B 
1,000
Quantity of
Cars Produced

35. Your turn now

36. Q1  Quantity of Computers Produced 3,000  D C 2,200 600 A 700 2,000
Suppose the country is producing at point C. If they want to have 100 more cars, how many computers do they have to give up?
What is the opportunity cost of one car at point C?
3,000  D C
2,200
600 A
700
2,000
Production
Possibilities
Frontier
1,000
300 B 
1,000
Quantity of
Cars Produced

37. The next question is tricky!

38. Q2  Quantity of Computers Produced 3,000  D C 2,200 600 A 700 2,000
Suppose the country is producing at point B. If they want to have 100 more cars, how many computers do they have to give up?
What is the opportunity cost of one car at point B?
Produced
3,000  D C
2,200
600 A
700
2,000
Production
Possibilities
Frontier
1,000
300 B 
1,000
Quantity of
Cars Produced

39. Finally, let’s go back to Sweden vs. the US healthcare question
“Citizens of Sweden are lucky because they have free health care while the citizens of the US have to pay for it.”

40. Sweden vs. the US (healthcare)
Cars US A B
Sweden
Healthcare

41. Measuring the costs and benefits of an action is not always very easy!

42. People sometimes count costs that should be ignored. Sunk costs

43. Example: Sunk costs
A group has arranged a bus trip to Niagara Falls. The driver’s fee is $100, the bus rental is $500 and the fuel costs $75. The driver’s fee is not refundable. The bus rental may be canceled a week in advance but there is a cancellation fee of $100. At $25 a ticket, how many people must buy tickets a week before so that canceling the trip is definitely a bad idea?

44. We have to make a decision because this is the last day for cancelling without paying the full amount of the bus rental. Suppose that 20 people bought tickets. Should we cancel the trip or not?
Driver’s fee is $100,
Bus rental $500
Fuel $75.
The driver’s fee is not refundable.
The bus rental cancellation fee $100.
Tickets $25

45. Should we go or cancel? Compare costs and benefits!
Benefit = number of tickets soldx$25 What is the cost of this trip? Driver’s fee $100 + the bus rental $500 + fuel costs $75 = $675 If we have sold $675/$25 = 27 tickets, benefits ≥ costs  go. Sunk cost : driver’s fee + cancellation fee = $200 Ignore $200 Relevant costs are $475 If we have sold $475/$25 = 19 tickets, benefits ≥ costs  go.

46. Failure to Ignore Sunk Costs
Sunk cost: A cost that is beyond recovery at the moment a decision must be made.
Sometimes people are influenced by sunk costs when they should be ignored.

47. Sunk Costs Sunk costs are borne whether or not an action is taken.
It is an expenditure that you cannot recover.
Therefore, they are irrelevant to a decision on whether to take an action.

48. Should you drive or take the bus?
You are planning a 1000-mile trip to Florida. Except for the matter of cost, you are completely indifferent between driving and taking the bus. Bus fare is $130.
The cost of operating your car during a typical 10,000-mile driving year is as follows:
Insurance 5$500
Car loan repayment $1000
Fuel & oil 5$600
Tires 5$100
License & registration 55$25
Maintenance 5$550 _+
Total $2775

49. End of the lecture