Question

Suppose you had \(\$ 1,000\) to spend. If you spent it on a vacation trip rather than on new clothes, your second choice, or 1,000 lottery tickets, your third choice, what was your opportunity cost of going on a vacation trip? (LO4) a) \(\$ 1,000\) b) the vacation trip itself c) not buying the new clothes d) not buying the lottery tickets e) missing out on the \(\$ 10\) million lottery prize

Short answer

The short answer to the question is: c) not buying the new clothes.

Step-by-step solution

Understanding the definition of opportunity cost

Opportunity cost refers to the value of the next best alternative that is given up when a choice is made.

Identifying the choices

Here, the choices are: 1. Spending $1,000 on a vacation trip. 2. Spending $1,000 on new clothes. 3. Buying 1,000 lottery tickets.

Understanding the scenario

In this scenario, the person chooses to spend the $1,000 on a vacation trip, and as a consequence, they don't spend it on new clothes (their second choice) or buy lottery tickets (their third choice).

Determining the opportunity cost

Since opportunity cost is the value of the next best alternative, the opportunity cost here would be the value of the person's second choice, which is not buying the new clothes. So, the correct answer is: c) not buying the new clothes

Key concepts

Economic Decision Making

Economic decision making is the process of choosing among alternatives to maximize benefits and minimize costs. It involves weighing the pros and cons of each option to determine the best course of action. In the context of the given exercise, the decision was between spending \(\$1,000\) on a vacation, new clothes, or lottery tickets. To make an informed economic decision, the individual would assess the personal satisfaction or utility derived from each option.

For example, the vacation might offer relaxation and memories, the clothes could enhance wardrobe and confidence, while the lottery tickets present a potential for a significant financial gain. The decision ultimately taken reflects the individual's priorities and values, often influenced by their immediate needs and long-term goals.

Thorough economic decision making also involves considering potential downsides, like the risk associated with the lottery or the transient nature of a vacation's enjoyment. By evaluating the implications of each choice, individuals apply economic reasoning to their personal circumstances, aligning with the concept of opportunity cost as the guiding factor in making sound decisions.

Cost-Benefit Analysis

Cost-benefit analysis is a systematic approach to estimate the strengths and weaknesses of alternatives. It's used to determine options that provide the best approach to achieving benefits while preserving savings. For instance, in the exercise, cost-benefit analysis would involve evaluating the tangible and intangible benefits of the vacation, clothes, and lottery tickets against the \(\$1,000\) expenditure.

One might consider the longevity and utility of clothes against the ephemeral, yet enriching experience of a trip. The lottery tickets offer a low probability of a high reward, a benefit that's largely speculative. In cost-benefit analysis, you often assign a monetary value to both costs and benefits, but personal values and utility play a crucial role, especially when the comparison involves non-financial aspects. The chosen option should ideally show a net positive value, which means the benefits outweigh the costs.

Students can improve their understanding by practicing scenarios where they list potential costs and benefits, then rank them based on their importance. This method teaches them to quantify their preferences and make decisions that are rational from both an economic and personal perspective.

Trade-Offs in Economics

Trade-offs in economics refer to the concept that in order to gain something, something else must be given up. Every decision has a trade-off, because resources such as time, money, and effort are limited. In the exercise, the trade-off is between the immediate pleasure of a vacation, the practical use of new clothes, and the gamble on lottery tickets.

Understanding trade-offs is crucial as it reveals the cost of choices. It emphasizes that every decision comes at the expense of an alternative. When you chose the vacation, the trade-off was the utility or satisfaction that could have been derived from purchasing new clothes or the thrill and slim chance of winning a lottery prize.

In practical terms, students should learn to always consider what they're giving up when making a choice. This exercise encourages the comparison of different trade-offs to comprehend which sacrifices are worth making. Clearly analyzing trade-offs aids in managing limited resources wisely and is a fundamental skill in both personal finance and broader economic policy.