Cost-Benefit Analysis

Optimal Decision-making and Opportunity Cost

• we assume rational people would want to maximize the difference between benefits minus cost

• there are explicit cost and implicit cost

• opportunity cost - cost of the next best alternative

• explicit cost are a transaction that has measurable cost to a firm

  • Purchase of new assets

  • Hiring of workers

  • Purchase of raw materials

• implicit cost are a decision which leads to lower income, but is not recorded on balance sheet

  • ex: giving workers a day off— will lead to a drop in sales and income

• opportunity cost includes both implicit and explicit cost

• if something cannot be broken down incrementally, u cannot examine the marginal costs and marginal benefits

• total cost: implicit cost + explicit cost

Accounting Profit vs Economic Profit

• total revenue = price x quantity

• accounting proft = explicit costs

• economic profit = total revenue - total cost (explicit - implicit)

• economic profit will never be higher than accounting profit

Introduction to Utility

• utility = satisfaction, usefulness, worth value

• units of utility are utils