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Video transcript

- [Instructor] What we're going to do in this video is think about optimal decision making by rational agents. And it's just thinking about how would a logical, someone with a lot of reasoning ability, make optimal decisions, make the best decisions for themselves? Well they would look at the costs and benefits of a decision and they would try to do the action that maximizes the difference between benefits and costs. So they would wanna maximize benefits, benefits minus costs. And this is an important idea because I think all of us would like to be rational agents, logical agents, making optimal decisions. Now when we think about benefits and costs, benefits you might try to quantify it somehow, maybe in terms of dollars. What's the benefit of say going to a movie or having some ice cream? And costs, we tend to associate with a price, the cost of going to a movie say might be $10. Those types of things are known as explicit costs, when there's an explicit price associated with it. But there's also something known as implicit costs, and the most well-defined implicit cost is the idea of an opportunity cost. And the opportunity cost in economic terms is defined as the cost of the next best alternative. So if I'm going to go to a movie, there might be the explicit costs of paying for the movie, but then there's the implicit cost. Maybe if I'm going to a movie, that time I could've used for something else. Maybe I could've earned money somehow. And so a rational actor would consider both of those and then compare them to the benefit of going to the movie, and if that's what maximizes the difference between benefits and costs, well they might decide to do that. Now to make this a little bit more tangible, let's look at that exact example. So right over here, we are told, suppose you have the choice between going to a movie for three hours versus working for three hours. Movie tickets cost $10. If you work, you can earn $30 an hour mowing lawns, $12 an hour working in an ice cream shop, or $10 an hour weeding your aunt's garden. What is the opportunity cost of going to a movie for three hours? And what is the total cost? So pause this video and see if you can figure that out. All right well we just have to go back to the definition. The opportunity cost is the cost of the next best alternative. So what is the next best alternative to going to the movie? Well, I can make the most money if I am mowing lawns, if I am mowing lawns. And so my opportunity cost is going to be $30 an hour, and if I'm going to a movie, that would've been three hours that I would not have been able to mow lawns. And so my opportunity cost, I'll write OC, I'm not talking about Orange County, the opportunity cost right over here is going to be $30 an hour times three hours, so 30 times three, which is going to be a $90, $90 opportunity cost. Now some of you might be saying, well what about the $12 an hour for an ice cream shop or $10 an hour for weeding your aunt's garden? Well, those weren't the next best alternative. The next best alternative was mowing the lawn. Some people might be confused and say, okay I'm gonna add all of these together per hour and multiply by three, but you're not gonna be able to do all three of these things. You're going to have to pick one of them. And we're assuming that maybe there aren't any extra costs that are not, maybe you get extra tired from mowing lawns versus working in an ice cream shop, but we're trying to simplify things, so let's not get overly complicated right now. So at a very face level or at a high level, the next best alternative is making $30 an hour mowing lawns. So that would be the opportunity cost. Now what would be the total cost? Well the total cost would be the sum of the implicit costs, which is opportunity cost is an example of that, plus the explicit cost. So the implicit costs, we already talked about that, that is $90. That's the cost of not, that's the opportunity cost of not mowing lawns. And then to that you're gonna add the explicit cost of just the price of the movie ticket. For $10 you get to watch a movie for three hours. So there's a $10 explicit cost. So the total cost of going to the movie is $100. And so how would an optimal decision or how would a rational agent use this information to make an optimal decision? Well they would wanna compare that to the benefit of going to a movie. And so if they could quantify that benefit somehow and say oh, yeah, the benefit to me of going to a movie is $200 and that difference between $200 and $100, that's the best difference that I can get out of all of my choices between my benefits and my costs. Well then I'm going to go to that movie. So I will leave you there and in future videos, we'll dig a little bit deeper into this.
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