Scarcity, Trade-offs, and Cost/Benefit Analysis - YouTube

As human beings, what do we want and need? We  certainly all need food, water, and shelter.  

And our wants may range from wealth to  adventure to entertainment. These wants  

and needs are without bounds, but even though we  have endless wants and needs, everything runs out.  

Food gets eaten. Money gets spent. And the Netflix  show you’re currently binging has a final season.  

The things that fulfill our wants and needs are  finite in nature. As we learned in the previous  

tutorial, this idea is called scarcity, and it  drives everything in economics. We make personal  

choices, business choices, and collective choices  differently, but we all do so based on scarcity.  

We can’t do everything or have everything, so we  must weigh our options and make the best choice  

for ourselves that we can, based on our situation. All choices involve trade-offs. A trade-off is the  

act of giving up one benefit in order to  gain another potentially greater benefit.  

For example, you are benefiting from  watching this tutorial right now,  

but you chose to watch it because the perceived  benefit of watching this tutorial outweighs  

other things that also could benefit you. Right  now, you could instead be playing video games,  

or fishing, or rollerblading, or watching  Netflix, or building birdhouses. All of those  

things could benefit you. But watching this  tutorial benefits you more at this moment.  

When a restaurant makes a choice to pay its  servers higher wages, it may have to be at the  

cost of spending money on advertising, or buying  new appliances, or even paying its custodians  

higher wages. When a government makes the choice  to spend more money on combat drones and bombs,  

it may have to be at the cost of spending more  money on education, healthcare, or fixing roads. 

Whenever we make a choice, there is always an  opportunity cost. Opportunity cost is the next  

best thing we give up by making that choice. It’s  essentially the most desirable alternate choice,  

something which is useful to identify when making  decisions because it reminds us to compare the  

value associated with various options. Going  back to our earlier example of you choosing  

to watch this tutorial, say you were to rank  your alternate choices of playing video games,  

fishing, rollerblading, watching Netflix,  and building birdhouses in this order.  

Remember, you chose to watch this video, so these  are your next best choices. But your opportunity  

cost is watching Netflix, since that is your  very next best choice, and you are giving up  

the opportunity to watch Netflix at this moment  by choosing to watch this tutorial instead. 

Let’s look at another example. Every night, we  make a choice regarding when to go to sleep.  

Say you normally get eight hours of sleep,  but you only get five hours of sleep one  

night since you stayed up late studying three  hours for an economics test. Your alternatives  

were eight hours of sleep and no studying,  seven hours of sleep and one hour of studying,  

or six hours of sleep and two hours of  studying. What is your opportunity cost? Well,  

it depends on who you are, but if you value  studying over sleep you might rank the options  

in this way, with the options becoming less  desirable as the increment of study decreases.  

According to this ranking, the opportunity cost  associated with an extra three hours of studying  

rather than two is the additional  hour of sleep you gave up. 

This ranking of choices leads to the idea  of something called thinking at the margin.  

Thinking at the margin has to do with making  decisions based on small changes in the allocation  

of resources. So one way of framing this concept  involves deciding how much more or how much less  

to do something, with all else held equal.  Looking at the sleep versus studying example,  

you’d be thinking at the margin if you thought  about answering the question: What is the proper  

balance of sleeping versus studying in order  to best prepare for the test? The process of  

making a decision like this is sometimes called a  cost/benefit analysis. To make rational choices,  

we weigh marginal costs versus marginal benefits.  These are terms that refer to either the cost  

added or benefit gained that is associated  with one additional unit of a good or service.  

In this particular case we could consider the  marginal cost of studying to be how much more  

tired you are the next morning due to having  slept one hour less. Perhaps a lot more tired,  

perhaps it’s negligible. And the marginal  benefit of studying would be the information  

you learn or retain from one additional hour  of studying. Maybe it doesn’t help much,  

and perhaps that one hour raises your grade from  a B to an A. If we could rigidly quantify the cost  

of sleeping less as well as the benefit of  studying more, we could hypothetically arrive  

at a firm answer to this particular predicament. The average adult makes around 35,000 choices  

per day. Most of these choices are automatic,  but the more important the choice, the more  

effort that typically goes into the cost/benefit  analysis. Recognizing and weighing the trade-offs,  

thinking at the margin, and considering  the opportunity cost of every choice is  

a mental exercise that can help make the  big decisions in life a little easier.  

And now we understand the concepts of scarcity,  trade-offs, and cost/benefit analysis.