Question

Suppose you are considering whether to go to Paris with a group of friends
during your Christmas holiday. The round trip airfare from Hong Kong to

Paris is $12,000, but you have an option to pay this airfare with a frequent-
flyer coupon. All other relevant costs of the vacation in Paris add up to

$15,000. The most you will be willing to pay for the Paris trip is $25,000,
which indicates the benefit you can gain from this trip. The only alternative
use of the frequent-flyer coupon is for a trip to New York after Christmas.
The Hong Kong-New York round-trip airfare will be 15,000 at that time.

a) Suppose you decide to use the frequent-flyer coupon for the Paris
trip. What is the opportunity cost of using this coupon?
b) What are the economic costs and economic surplus of your trip to
Paris if you use the frequent-flyer coupon for this trip? Will you take
the Paris trip?
c) Suppose something happens in your family that makes you realize
you will not be able to go to New York after Christmas. Will you
take the Paris trip?

Answer 1

1.A) Opportunity cost is defined as the value of something that is forgone or given up to undertake an action. If I decide to use the frequent-flyer coupon for Paris trip, the alternative of using the coupon for New York trip is given up. Hence, the opportunity cost here is $15000.

1.B) Economic cost = Implicit Cost + Explicit cost

Implicit Cost is generally the opportunity cost of an action. Here the implicit cost would be $15000.

Explicit Cost is all the relevant costs of doing an action. In this case, it is $15000.

Hence, Economic Cost= $15,000 + $15,000 = $30,000

Economic surplus = Economic Benefits – Economic Costs

The economic benefit is the most I would be willing to pay for the Paris vacation, while the economic costs have been obtained as above.

Economic surplus = $25000– $30000 = -$5000

As the Economic Surplus is negative, I will not choose to take the Paris trip.

1.C) If I will not be taking the New York trip post-Christmas, then my opportunity Cost will be zero. My economic surplus will be $10,000 which is positive. Hence, I will take the Paris trip.