Unit 3 Week 1 Notes — Either-Or Decisions, Costs & Economic Profit

Introduction & Course Context

• Week 1 of Unit 3: “Doing the Best You Can – Scarcity, Well-Being & Working Hours.”

  • Purpose: lay conceptual groundwork before tackling the more complex consumer-choice models scheduled for next week.

  • Assigned textbook reading this week: Sections 3.1 & 3.2 only.

  • Core themes introduced: scarcity, choice, rational consumer behaviour, different modes of decision-making, and the interplay of preferences with budget constraints.

Key Economic Principles Refreshed

• Scarcity forces individuals and firms to make choices.

• Optimal decision-making occurs where what we want (preferences) meets what we can afford (budget constraint).

• The rational consumer framework helps predict or prescribe “good” choices.

• Today’s lecture = simplified version that will be generalized next week (dynamic settings, movable constraints, richer preference maps).

Two Types of Decisions (Preview)

• Either-Or decisions (today’s focus).

• “How-Much” or marginal decisions (coming later).

Either-Or Decisions

• Definition: A finite set of discrete alternatives; you must pick one.

• Familiar life examples:
  • Go back to school vs. keep working.
  • Eat out vs. cook at home.
  • Get married vs. remain single, etc.

• Analytical recipe:

  1. List costs & benefits for each option.

  2. Convert all costs into $\text{explicit} + \text{implicit}$ dollar terms.

  3. Compute economic profit for at least one option; sign (+/–) is enough to identify the preferred choice when only two alternatives are present.

  4. Pick the option with positive economic profit. If both positive, choose the higher; if both negative, choose the “least-bad” (closest to zero) or reconsider additional options.

Cost Vocabulary

• Explicit Cost: direct, out-of-pocket monetary expenditure (e.g., tuition, rent, wages paid).

• Implicit Cost: opportunity cost of the next-best alternative that is not chosen; denominated in \ even if no cash changes hands.

• Accounting Profit: $\text{Revenue}-\text{Explicit Cost}$ (what a bookkOpportunity Cost:
  $\text{Opportunity Cost}=\text{Explicit Cost}+\text{Implicit Cost}$

• Reminder: do not ignore implicit cost; both components matter.

Profit Vocabulary

• Generic formula: $\text{Profit}=\text{Revenue}-\text{Cost}$

• eeper reports).

• Economic Profit: $\text{Revenue}-\big(\text{Explicit}+\text{Implicit}\big)=\text{Revenue}-\text{Opportunity Cost}$.

• Decision rule for either-or: choose the option with positive economic profit.

Worked Example 1 – Latoya’s Business Idea vs. Her Job

• Current job salary: $40\,000$ per year.

• If she starts a business she must:
  • Rent workspace: $10\,000$
  • Buy supplies: $5\,000$
  • Hire employee: $20\,000$

• Expected business revenue: $50\,000$

• Step-by-step:
  • Explicit Cost $=10\,000+5\,000+20\,000=35\,000$
  • Implicit Cost $=40\,000$ (foregone salary)
  • Opportunity Cost $=35\,000+40\,000=75\,000$
  • Accounting Profit $=50\,000-35\,000=15\,000$
  • Economic Profit $=50\,000-75\,000=-25\,000$ (lecture verbally cites –$2,500; correct arithmetic is –$25,000—either way negative).

• Decision: Stay in current job (positive economic profit of job vs. negative for business).

• Insight: with only two choices, calculating one economic profit (business) suffices; the other must be of opposite sign.

Capital & Its Implicit Cost

• Capital = total value of physical & financial assets owned by an individual or firm.
  • Physical: real estate, machinery, computers.
  • Financial: savings, bonds, stock holdings.

• Key pitfall: If you own the capital you intend to use, still include its implicit cost (income/value you forgo by not deploying it elsewhere).
  $\text{Implicit Cost of Owned Capital}=\text{Income the capital could earn elsewhere}$

Worked Example 2 – Latoya Owns Capital & Uses Husband’s Labor

• New scenario:
  • Latoya owns suitable space (market rental value $10\,000$).
  • Husband will work for “free,” but currently earns $20\,000$ elsewhere.
  • Supplies still cost $5\,000$.

• Costs recast:
  • Explicit Cost $=5\,000$ (supplies only).
  • Implicit Cost $=40\,000+10\,000+20\,000=70\,000$ (Latoya’s forgone salary + foregone rent + husband’s forgone salary).
  • Opportunity Cost unchanged $=75\,000$.

• Economic Profit with same $50\,000$ revenue remains $-25\,000$ ⇒ Still a bad idea.

• Takeaway: shifting who owns or supplies resources just moves terms between “explicit” and “implicit” columns; total opportunity cost—and thus the decision—can remain identical.

Extending Either-Or to More Than Two Options

• Procedure:

  1. Evaluate any two alternatives; discard the one with negative economic profit.

  2. Compare the surviving option to a third choice.

  3. Repeat until all possibilities considered; final survivor has the highest (positive) economic profit.

Worked Example 3 – Adding the Stay-At-Home Parent Option

• Third alternative: Latoya becomes a stay-at-home mom.
  • Valued home production/ savings: $45\,000$
  • Forgone salary remains $40\,000$ (implicit cost).

• Economic Profit:
  $45\,000-40\,000=+5\,000$

• Comparing:
  • Job: economic profit $=0$ (implicit because her opportunity cost equals salary).
  • Home business: $-25\,000$.
  ⇒ Best choice = stay-at-home mom (highest positive economic profit).

Ethical & Practical Reflections

• Implicit valuation (e.g., value of parenting, use of an extra room) depends on personal or societal context; economists translate these into $$ for analytical clarity, which may spark philosophical debate.

• Recognizing opportunity costs helps avoid “free-resource” fallacies (believing owned capital or family labor is costless).

• Applying economic-profit logic to household decisions underscores the universality of economic reasoning beyond formal firms.

Looking Ahead

• Today: foundational logic for discrete choice (either-or).

• Next week:
  • “How-much” (marginal) decision-making.
  • Introducing indifference curves, budget lines, and dynamic shifts (prices, income, preferences).
  • Extending analysis to working-hours choice and well-being under scarcity.

Practical Study Tip: Before next lecture, practice enumerating explicit vs. implicit costs for personal life decisions; compute accounting vs. economic profit to solidify intuition.