hi everybody jacob reed here from review econ.com today we're going to be talking about opportunity cost and cost benefit analysis if after watching this video you still need a little more help head over to reviewecon.com and pick up the total review booklet it has everything you need to know to ace your microeconomics or macroeconomics ap exams let's get into the content now opportunity cost is one of the most important concepts in microeconomics and if we're going to understand it we need to start off with a definition the definition of opportunity cost is the value of the next best alternative not chosen so you choose to do one thing and the thing that you would have done had you not done what you did the value of that is your opportunity cost essentially opportunity cost is the cost associated with the choice now economists have an acronym to emphasize opportunity cost it's 10 stoffel tinstoffel means there is no such thing as a free lunch in fact most economists say there's no such thing as free and that's because everything has a cost or opportunity cost in ap microeconomics when you see the word cost opportunity cost is a synonym they're really the same word and that's because with any choice you will lose your next best alternative and the value of that is your cost or opportunity cost so if you choose to go to school you are going to lose the opportunity to play video games maybe some fortnight if you choose to go to work you lose the opportunity to spend time with your friends and if you buy one product perhaps a candy bar you lose the opportunity to spend that money on other products like a soda now when it comes to opportunity costs we actually have two types of cost the first type of cost is explicit cost that's what most people think of when they hear the word cost explicit cost is the money you have paid when you make a choice it's the money that comes out of your wallet to pay for a particular experience product good service whatever it is but many choices have an implicit cost as well implicit costs are the lost earnings or the value of the opportunities lost as a result of a particular choice so this is the cost associated with a choice that is above and beyond the money paid when it comes to calculating opportunity costs we're going to focus on the cost of a choice you're going to add the implicit costs and the explicit costs together to get your full opportunity cost so let's say that you go to a movie and you pay twenty dollars for that movie ticket and that twenty dollar ticket is an explicit cost as a result of your choice to go to the movies let's say you also buy some popcorn and that popcorn is ten dollars that popcorn is also an explicit cost you're paying the money out of your wallet for the experience of going to the movies so we've got thirty dollars worth of explicit cost as a result of choosing to go to the movies but perhaps that same day you had the opportunity to go to work you took the day off so that you could go to that movie the sixty dollars you could have earned during that shift is an implicit cost associated with going to the movies so when it comes to calculating the full opportunity cost because you chose to go to the movies we are going to add the explicit costs to the implicit cost to get the full cost so that movie didn't cost the 30 for the ticket and the popcorn it actually cost 90 because we're adding both the explicit and implicit costs together those are the costs associated with the choice of going to the movies it's the value of the next best alternative not chosen the next best alternative would have been to go to work and earn 60 and you would have had 30 that you could have spent on other products so you lose the value of those products as well the two together explicit and implicit are your opportunity costs now let's talk about some things that you might see in your questions that are not part of the choice and therefore not part of the cost let's say the retail value of that ticket was 25 but you got a 20 discount on that ticket so you actually spent 20 dollars the true value of that purchase the 25 that is not a cost to you it's not relevant to the problem here the amount of money you spent the explicit cost to you the decision maker was 20 so that's the number we're going to focus on here not the value of 25 there also may be some expenses that are outside the cost of the choice let's say you would have had to pay five dollars in gas to go to the movies and five dollars in gas to go to work since you would have paid five dollars either way the cost of the gasoline is not part of the choice so we're not going to count it as an opportunity cost for the choice of going to the movies we're also not going to look at other alternatives perhaps instead of going to work or going to the movies you could have babysat a friend's child and earned 40 there since 40 is less than the 60 you would have earned it work it's not as good of a choice and you ended up choosing a better option in your opinion going to the movies so the third choice of babysitting not relevant whatever you would have earned doing that is not part of this opportunity cost equation so we're focusing on the choice here you just add the explicit and implicit costs that are associated with the choice and adding those together now here's an example from the 2012 practice ap microeconomics exam read through it for a moment and see if you can figure out peggy smith's true opportunity cost for going to college so her explicit costs for tuition and fees is 4 600 annually and she will also have a cost of the lost wages that she could have earned had she not gone to college so based on this question peggy smith's full opportunity cost of going to college is add the explicit and implicit costs together 16 600 annually and in real life for many college students the implicit cost of lost wages while in college will outweigh the explicit cost of tuitions and fees now we can see opportunity costs on a production possibilities curve moving production from point a where we have 65 capital goods and 35 consumer goods to production point b where we have 30 capital goods and 75 consumer goods we will have a benefit of 40 more units of consumer goods being produced but those 40 units of consumer goods are not free they come at an opportunity cost of 35 units of capital goods now let's take this idea of opportunity cost and apply it to cost benefit analysis so we can see how some decisions are made in economics so we have our total cost often called opportunity cost in ap microeconomics which is your explicit costs and implicit costs added together you also have your total benefit that's the enhancement to your own personal well-being and perhaps the well-being of society as a whole you could see this term total net benefit that's the total benefit minus the total cost if you have a positive net benefit that means the benefits are greater than the cost if you have a negative net benefit it means the costs outweigh the benefits when it comes to people making rational choices they are going to act when total benefits are greater than total costs or when there is a positive net benefit let's say your local parks and recreations district is deciding whether or not they should build a new park if that park costs 1 million dollars to bill but there will be a total benefit to the community of 1.5 million dollars should this city build the park well they should build the park and that's because 1.5 million dollars worth of benefit is greater than the 1 million dollars worth of cost and there is a positive net benefit of half a million dollars on an individual level you could be deciding whether or not to get a haircut and that haircut could cost twenty dollars and currently given the current length you have about fifteen dollars worth of benefit for getting the haircut should you get your hair cut today well the answer is no because fifteen dollars worth of benefit is less than the twenty dollars of cost you have a negative net benefit here of five dollars and there you have it that is everything you need to know about opportunity cost and cost benefit analysis now most decisions are actually made at the margin we're going to learn about marginal analysis how most decisions are made in the next video if you're ready to practice calculating opportunity costs head over to review econ.com and play the opportunity cost calculation gain if you still need more help after that head over to reviewecon.com and pick up the total review booklet it has everything you need to know to ace your microeconomics or macroeconomics ap exams that's it for now i'll see you all next time