Bài giảng Microeconomics - Chapter 2 Some Common Pitfalls for Decision Makers

Some Common Pitfalls for Decision Makers0What is Chapter 2 about?1Pitfall #1: Ignoring Opportunity CostsSlide 2 - 22Opportunity CostThe value of the next-best alternative that must be forgone in order to engage in a particular activity3What’s “Free”?Using a good we already own is not freecould be sold in the marketplace instead possible sales proceeds = opportunity costAsk yourself – what am I giving up ?“Should I iron my shirt OR watch the end of the movie?Not just, “Should I iron my shirt?”4Opportunity Cost Over TimePay Now or Pay Later ?You are always better off if you can delay payment – unless you have to pay interestDelayed payments mean $ can be invested (and earn interest) in the meanwhileOpportunity cost of paying now, instead of paying later, is foregone interestImplication: paying a dollar a year from now is not the same as paying a dollar today5Suppose you win the lotteryWould you prefer to:Receive $1,000,000 nowReceive $50,000 per year for 20 yearsYou could take the $1,000,000 & investAt 5% interest, implies $50,000 per year forever6Time Value of MoneyA given dollar amount in the future is equal to a smaller dollar amount todayAlternatively, a given amount today is equal to a larger amount tomorrowWhy ? - Money can be invested in an interest-bearing account in the meantimeTo pay $10 a year from now (if the interest rate is 10%), you could put about $9.10 in the bank now$9.10 invested now + one year’s interest would cover a payment of $10 in one year’s timeImplication: the Present Value of $10 in one year from now is only $9.10 today (at 10%)7Loan interest rates: RationaleBanks pay interest to depositers to compensate them for not using their money right away What could lenders do with the money right away?What is the opportunity cost of their deposit ?could spend it on consumption nowmight be able to invest it in a real asset whose value grows If lenders’ opportunity cost is relatively low, will deposit $ in bank but why would a lender give the money out without some compensation? Higher interest rate needed if depositers’ opportunities or needs are stronger.8Ignoring Opportunity Costs: SummaryIt is important to account for all relevant opportunity costsThe value of a resource depends upon its best alternative use, even if you got it “free”Remember to count the time value of money9Pitfall #2: Failure to Ignore Sunk CostsSlide 2 - 1010Sunk Costs and Decision-MakingSunk costs are those costs that will be incurred whether or not an action is takenE.g., money that you cannot recoverTherefore irrelevant to decision on whether to take an action should NOT be counted for decision-making purposesRational decision makers compare benefits to only the additional costs that must be incurred11The used car exampleSuppose: Paid $5,000 for car, still owe $3,000 on car loanEngine just brokeAs is, could sell for $200Will cost $1,500 to fix engine – can then sell for $2,000Which costs are relevant to decision?Which costs are sunk costs ?What’s the optimal decision ?12Sunk Costs and Decisions: SummaryIgnore sunk costs—because they are unavoidable, whatever action is taken. Count only the extra costs and benefits of possible actions, and choose the action with the highest net gain.13Pitfall #3: Failure to Understand the Average-Marginal DistinctionSlide 2 - 1414Failure to Understand the Average-Marginal DecisionThe relevant costs and benefits for decision-making are always marginalAt every step - compare the additional costs and benefits of that step before taking it.15Average vs. MarginalAverage costs = total costs per unit of activityAverage benefits = total benefits per unit of activityMarginal concepts are relevant for decisionsMarginal cost = the additional costs of adding a unit of activityMarginal benefit = the additional benefits of adding a unit of activity16Positive Net GainComparing the marginal cost to the marginal benefit of the next step tells whether or not there is a net gain for that stepIf the net gain is positive, then the next unit of activity should be undertaken17Allocation of Resources – maximizing total outputAllocate each unit of a resource to the production activity that has the highest marginal net benefitBalance the allocation so that the marginal net benefit is the same in every activityIf the marginal net benefits are not equalized, re-allocation of resources will increase outputMaximum output when equalize marginal net benefits in every activityNote: Net Benefit = Benefit - Cost18Costs and Level of ActivityFixed CostsCosts that do not vary with the level of an activityVariable CostsCosts that do vary with the level of an activity19Ignoring Average-Marginal Distinction: SummaryCost-benefit principleThe level of an activity should be increased if, and only if, marginal net benefit is positive – I.e. the marginal benefit exceeds the marginal costNot “if the average benefit exceeds the average costs”20End of Chapter SlidesConcept Maps meant for student printouts follow.Concept Map slides are also available in pdf format.Slide 2 - 2121What is Chapter 2 about?22Pitfall #1: Ignoring Opportunity Costs23Pitfall #2: Failure to Ignore Sunk Costs24Pitfall #3: Failure to Understand the Average-Marginal Distinction25Summary of Chapter 226