Economic Cost

For this first assignment you are to put together a tutorial that explains what opportunity costs are and how they are used in economic reasoning and decision making. Provide clear, practical examples of opportunity costs being utilized well in decisions (leads to increases in value) and opportunity costs utilized poorly in decision making (value is not maximized).

utilizing at least one outside scholarly or professional source related to organizational behavior. This source should be a published article in a scholarly journal. This source should provide substance and not just be mentioned briefly to fulfill this criteria. The textbook should also be utilized. Do not use quotes. Do not insert excess line spacing. APA formatting and citation should be used.

The One Lesson of Business

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CHAPTER

Voluntary transactions create wealth by moving assets from lower- to higher-valued uses.

Anything that impedes the movement of assets to higher-valued uses, like taxes, subsidies, or price controls, destroys wealth.

Economic analysis is useful to business for identifying assets in lower-valued uses.

The art of business consists of identifying assets in low-valued uses and devising ways to profitably move them to higher-valued ones.

A company can be thought of as a series of transactions. A well-designed organization rewards employees who identify and consummate profitable transactions or who stop unprofitable ones.

Kidney Transplants

Two prominent hospitals recently refused patients for kidney transplants because the organs were from “directed donations.”

The kidneys were meant for specific people

Demand for organs is high – far exceeding supply – and many never receive them.

Despite high demand and low supply, buying and selling organs is illegal.

Why?

Apartments

Suppose you want to move from Detroit to Nashville

First, you would try a two-way trade

Failing that, you’d try a three-way connection with another city

Need to find correct trades with correct timing = difficult!

Like with kidney transplants, compatibility problems lead to inefficiency

Detroit Nashville

Los Angeles

Capitalism 101

To identify money-making opportunities, you must first understand how wealth is created (and sometimes destroyed).

Key note: Wealth is created when assets are moved from lower to higher-valued uses

Definition: Value = willingness to pay

Desire + Income = You want something + you can pay for it

Key note: Voluntary transactions, between individuals or firms, create wealth.

Meaning, people create wealth by pursuing self-interest.

Housing Example

A house is for sale:

The buyer values the house at $130,000

This is the buyer’s top dollar – willingness to pay

The seller values the house at $120,000

This is the seller’s bottom line – won’t accept less

The buyer and seller must agree to a price that “splits” surplus between buyer and seller. Here, $128,000.

Surplus

The buyer and seller both benefit from this transaction:

Buyer surplus = buyer’s value minus the price

$130,000 – $128,000 = $2,000 buyer surplus

Seller surplus = the price minus the seller’s value

$128,000 – $120,000 = $8,000 seller surplus

Total surplus = buyer + seller surplus = difference in values

$2,000 + $8,000 = $10,000  $130,000 – $120,000 = $10,000

$10,000 are the gains from trade

Wealth-Creating Transactions

Which assets do these transactions move to higher-valued uses?

• Factory Owners • Corporate Raiders

• Real Estate Agents • Insurance Salesman

• Investment Bankers

Discussion: How does eBay create wealth?

Discussion: Which individual has created the most wealth during your lifetime?

Discussion: How do you create wealth?

Do Mergers Create Wealth?

Do mergers follow the wealth-creating engine of capitalism? Do they move assets to a higher-valued use?

Our largest and most valuable assets are corporations.

Ex: Dell-Alienware merger:

In 2006, Dell purchased Alienware, a manufacturer of high-end gaming computers.

Dell left design, marketing, sales and support in Alienware’s hands.

Dell took over manufacturing though, using its expertise to build Alienware’s computers at a much lower cost.

Do Mergers Create Wealth?

However, many mergers and acquisitions do not create value

If they do, value creation is rarely so clear

To create value, the assets of the acquired firm must be more valuable to the buyer than to the seller

Does Government Create Wealth?

Discussion: What’s the government’s role is wealth creation?

Enforcing property rights and contracts legal tools that facilitate wealth creating transactions

Ensures that buyers and sellers keep gains from trade

Discussion: Why are some countries so poor?

No property rights

No rule of law

Discussion: Much of the justification for government intervention comes from the assertion that markets have failed. One money manager scoffed at this idea. “The markets are working fine, but they’re giving people answers that they don’t like, so people cry market failure.”

The One Lesson of Economics

Definition: An economy is efficient if all assets are employed in their highest-valued assets.

This is an unattainable, but useful benchmark

The One Lesson of Economics: The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.

Must look at the intended and unintended effects of policies to understand their efficiency

The economist’s solution to inefficient outcomes is to argue for a change in public policy.

Business person’s solution is to try to make money on the inefficiency

The One Lesson of Business

Definition: Inefficiency implies the existence of unconsummated, wealth-creating transactions

The One Lesson of Business: The art of business consists of identifying assets in lower valued uses and devising ways to profitably moving them to higher valued uses.

In other words, make money by identifying unconsummated wealth-creating transactions and devise ways to profitably consummate them.

Destroying Wealth

Anything that stops assets from moving to higher valued uses is destroying wealth.

Taxes Destroy Wealth:

By deterring wealth-creating transactions – when the tax is larger than the surplus for a transaction.

Subsidies Destroy Wealth:

Example: flood insurance encourages people to build in areas that they otherwise wouldn’t

Price Controls Destroy Wealth:

Example: rent control (price ceiling) in New York City deters transactions between owners and renters

Which assets end up in lower-valued uses?

Profiting from Inefficiency

Taxes create a profit opportunity

Discussion: 1983 Sweden tax

Subsidies create opportunity

Discussion: health insurance

Price-controls create opportunity

Discussion: Regulation Q. & euro dollars

Discussion: What about ethics?

Wealth Creation in Organizations

Companies = a collection of transactions

They buy raw materials (capital, labor, etc.) and create and sell higher-valued goods and services

Can equate market-level problems (taxes, subsidies and price controls) with organization-level goal alignment problems

Ex: The overbidding from the oil company = “subsidy” paid to management for acquiring oil reserves

Allows us to use the same analysis

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