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Optimal decision-making and opportunity costs | AP(R) Microeconomics | Khan Academy - YouTube
Channel: Khan Academy
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what we're going to do in this video is
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think about optimal decision making by
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rational agents and it's just thinking
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about how would a logical someone with a
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lot of reasoning ability make optimal
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decisions make the best decisions for
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themselves well they would look at the
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costs and benefits of a decision and
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they would try to do the action that
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maximizes the difference between
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benefits and costs so they would want to
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maximize benefits
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benefits
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minus costs and this is an important
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idea because i think all of us would
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like to be rational agents logical ra
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agents making optimal decisions
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now when we think about benefits and
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costs benefits you might try to quantify
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it somehow maybe in terms of dollars
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what's the benefit of say going to a
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movie or having some ice cream and costs
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we tend to associate with the price the
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cost of going to a movie say might be
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ten dollars
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those types of things are known as
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explicit costs when there's an explicit
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price associated with it but there's
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also something known as implicit costs
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and the most well-defined implicit cost
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is the idea of an opportunity cost
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and the opportunity cost in economic
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terms is defined as
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the cost of the next best alternative
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so if i'm going to go to a movie there
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might be the explicit cost of paying for
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the movie but then there's the implicit
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costs maybe if i'm going to a movie that
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time i could have used for something
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else maybe i could have earned money
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somehow and so a rational actor would
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consider both of those and then compare
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them to the benefit of going to the
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movie and if that's what maximizes the
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difference between benefits and costs
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well they might decide to do that
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now to make this a little bit more
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tangible let's look at that exact
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example
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so right over here we are told
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suppose you have the choice between
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going to a movie for three hours versus
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working for three hours
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movie tickets cost ten dollars
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if you work you can earn thirty dollars
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an hour mowing lawns twelve dollars an
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hour working in an ice cream shop or ten
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dollars an hour weeding your aunt's
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garden
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what is the opportunity cost of going to
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a movie for three hours and what is the
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total cost
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so pause this video and see if you can
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figure that out
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all right well we just have to go back
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to the definition the opportunity cost
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is the cost of the next best alternative
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so what is the next best alternative to
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going to the movie
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well i can make the most money if i am
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mowing lawns
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if i am mowing lawns
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and so my opportunity cost is going to
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be 30 an hour and if i'm going to a
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movie that would have been three hours
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that i would not have been able to mow
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lawns and so my opportunity cost i'll
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write oc i'm not talking about orange
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county
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the opportunity cost right over here is
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going to be
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dollars an hour times three hours so
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thirty times three which is going to be
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a ninety dollar ninety dollar
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opportunity cost
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now some of you might be saying well
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what about the twelve dollars an hour
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for an ice cream shop or ten dollars an
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hour for weeding your aunt's garden
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well those weren't the next best
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alternative the next best alternative
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was mowing the lawn some people might be
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confused and say okay i'm going to add
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all of these together per hour and
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multiply by 3 but you're not going to be
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able to do all three of these things
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you're going to have to pick one of them
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and we're assuming that maybe there
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aren't any extra costs that are not you
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know maybe you get extra tired from
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mowing lawns versus working in an ice
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cream shop but we're trying to simplify
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things so let's not get overly
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complicated right now so at a very face
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level or at a at a high level the next
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best alternative is making 30 an hour
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mowing lawns so that would be the
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opportunity cost now what would be the
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total cost well the total cost would be
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the sum of the
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implicit cost which is opportunity cost
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is an example of that plus the explicit
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cost so the implicit cost we already
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talked about that that is ninety dollars
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that's the cost of not this the
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opportunity cost of not mowing lawns and
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then to that you're going to add the
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explicit cost of just the price of the
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movie ticket for ten dollars you get to
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watch a movie for three hours
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so there's a 10 explicit cost so the
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total cost of going to the movie is 100
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and so how would an optimal decision or
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how would a rational agent use this
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information to make an optimal decision
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well they would want to compare that to
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the benefit of going to a movie and so
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if they could quantify that benefit
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somehow and say oh yeah the benefit to
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me of going to a movie is 200 and that
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difference between 200 and 100 that's
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the best difference that i can get out
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of all of my choices between my benefits
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and my costs well then i'm going to go
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to that movie
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so i will leave you there and in future
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videos we'll dig a little bit deeper
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into this
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