Difficulty: Medium
AACSB: Application of Knowledge
Topic: Cost‐Benefit Analysis
35) Which of the following statements is true?
A) A rational economic agent is not likely to optimize.
B) Cost‐benefit analysis can also be used for normative economic analysis.
C) Cost‐benefit analysis does not yield the same result as optimization analysis.
D) The net benefit of an option that costs $50 and provides a benefit of $100 is equal to $150.
Answer: B
Difficulty: Medium
AACSB: Analytical Thinking
Topic: Cost‐Benefit Analysis
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36) Wendy has to decide between taking a flight and driving to California. Air tickets cost $800 and will
get her to California in 2 hours. If she decides to drive, she would need $300 worth of gasoline and 10
hours to reach her destination. Suppose Wendyʹs opportunity cost of time is $20 per hour.
a) Assuming that there are no other costs involved, use cost‐benefit analysis to decide whether she should
fly or drive to California.
b) If Wendy has an important business meeting to attend and this increases her opportunity cost of time to
$200 per hour, will her optimum decision change? Explain.
Answer:
a) Cost‐benefit analysis is a calculation that adds up costs and benefits using a common unit of
measurement. It is used to identify the alternative that has the greatest net benefit, which is equivalent to
benefits minus costs. If Wendy decides to drive down instead of flying, she saves ($800 − $300) = $500. But
driving down to California takes an additional 8 hours of travel time. Therefore, the net benefit of driving
relative to flying is:
($500 Cost saving) − (8 hours Additional travel time) × ($20/hour) = $500 − $160 = $340. Because the net
benefit of driving is positive, driving to California is the optimum choice for Wendy when the opportunity
cost of time is $20 per hour.
b) If the opportunity cost of time changes, the net benefit of driving relative to flying will also change: Net
benefit of driving relative to flying when the opportunity cost of time is $200 per hour = ($500 Cost saving)
− (8 hours Additional travel time) × ($200/hour) = $500 − $1,600 = −$1,100.
Because the net benefit of driving relative to flying is negative, flying to California is the optimum choice
for Wendy when the opportunity cost of time is $200 per hour.
Difficulty: Medium
AACSB: Application of Knowledge
Topic: Cost‐Benefit Analysis
37) What is cost‐benefit analysis? What are the steps involved in using cost‐benefit analysis to make the
optimal choice?
Answer: Cost‐benefit analysis is a calculation that adds up the costs and benefits of a particular choice