S121 ECO504 BUSINESS ECONOMICS

Problems and Applications

1.1 a. The trade-off is the interest paid to the bank vs the cost of borrowing from family and

friends.

b. For a member of the government deciding whether to increase spending on a new military

hardware, the trade-off is between the new military hardware and other spending items or tax

cuts.

c. When a company chief executive decides whether to invest in new more efficient heating, the

CEO has to look at the effect of this on profits as opposed to investing the amount in

something else for increased profits.

d. The tradeoff is between the income earnt vs the value of time of the worker.

1.2. The opportunity cost of seeing a football match includes the monetary cost of admission

plus the time cost. The time cost depends on what else you might do with that time; if it's

working an extra three hours at your job, the time cost is the money you could have earned.

When the benefits of something are psychological, such as going to the football match, it isn't

easy to compare benefits to costs to determine if it's worth doing. But there are two ways to

think about the benefits. One is to compare going to the match with what you would do in its

place. If you didn't go, would you buy something like a new team football shirt?

1.3. The business knows that by putting the money in a bank it will safely earn €400. The

business will need to estimate the expected increase in profits if the fund was reinvested in the

business to perhaps improve marketing or buy new more efficient equipment.

1.4. The fact that you've already sunk €20 million isn't relevant to your decision anymore, since

that money is gone. What matters now is the chance to earn profits at the margin. If you spend

another €4 million and can generate sales of €12 million, you'll earn €8 million in marginal profit,

so you should do so. In fact, you'd pay up to €12 million to complete development; any more

than that, and you won't be increasing profit at the margin.

1.5. Team member one hasn’t accounted for the extra cost that maybe associated with increased

production. Team member two has mentioned lower average costs, but nothing on sales. Team

member three has looked at both marginal costs and marginal revenues. A firm wants to

maximize its profits, so it needs to examine both costs and revenues. So the third is right- it’s

best to examine whether the extra revenue would exceed the extra costs. The third witch is the

only one who is thinking at the margin.

1.6. Open discussion question. If fees for domestic students increase then the opportunity cost

will increase.