At the close of the last session, mentioned opportunity cost and how it stems from the three basic assumptions micro economists make about actors and markets. That whenever we pursue one of our goals, we're implicitly giving up the ability to pursue another goal. To a certain extent. And that needs to be factored in to the equation, to the decision making we undertake. Some costs are implict that are harder to measure. And then other costs are explicit, are much easier to measure. We often use terminology for accounting costs because accounting tends to gather the explicit the easy to measure costs. Whereas economic costs are meant to include both implicit and explicit costs. Not just the easy to measure stuff. But the harder to measure stuff. Let me give you an example. Many of you have thought, perhaps, of pursuing an MBA sometime down the road. A two year typically graduate business degree. Should you pursue such an MBA? And if so, when? Let me give you an example in our next slide. Imagine you, and you have a number of different routes, or choices you could make. One possibility is to pursue the MBA now. Another possibility is to wait for five years. It used to be very common up through the late 80s, that students right after college, would apply to a graduate business program for an MBA. Nowadays typically top tier schools, like the Simon School average about five years experience in their incoming MBA classes. So another branch of the decision tree you face might be to wait for five years. The third possibility is just keep working. after college, the job you have keep working and never pursue an MBA. And then fourth, maybe you want to take a break post college. Travel a little bit. See Europe, Asia. And then return to work and no MBA. There are a variety of other possible choices, branches of the decision tree. But let's just assume for starters that those are the four, that you would actively consider. If macro economists were to look at what went into your decision making, what he or she would determine was a calculus along the following lines. That you'd look at each of these potential choices, these potential goals you have. And you'd first figure out what are the easy to measure benefits associated with each choice? Take the case of pursuing the MBA now, and some of the benefits you'd have to estimate roughly. What will I end up making over the rest of my career if I pursue the MBA now? And measure that against the explicit cost. Tuition, parking, books, living arrangements, not just during the MBA and beyond. Now admittedly some of these costs and benefits, even if they're explicit, are hard to measure. Have to be estimated. Then what you would do, is look at the difference between the explicit costs. And the, sorry, the explicit benefits and the explicit costs and determine the explicit profits, the accounting profits in a sense. The easy to measure stuff. And let's say in this hypothetical case that the explicit benefits totalled $ 2 million, whereas the explicit costs were half that, a $ 1 million. So, to an economist, that branch that potential decision would involve an accounting profit of a $1 million. But that's just one possible choice. What about the others? The pursuing the MBA waiting for five years, let's see who also totalled those benefits. And that they came to $ 2 million on the be, on the explicit benefit side, but the costs were higher 1.2 million. The costs would be higher because if you waited five years, you'd, you'd be giving up a salary in real terms that was higher in all likelihood than if you pursued the MBA now. And so pursuing that choice, looking at the accounting profits, it would end up totalling to $800,000. Third option, you can just keep working, never pursue the MBA. Let's say the estimated explicit benefits were $1 million, whereas the explicit costs were $800,000. So the net, the accounting profit from that choice totalled to $ 200,000. And then the fourth choice, let's say you decided to take a year or two off to travel. Then work and still no no MBA. You might see the Acropolis, you may see the Great Wall of China. And again, measuring those benefits can be very difficult, can vary across people but presumably you'd factor that in. You'd put some number on that as you're making your decision and determine those explicit benefits minus the explicit costs. And let's say the accounting profits that fourth choice, total to $100,000. To an accountant you would end up wanting to pursue your most profitable choice. The first one that generates accounting profits of a million dollars. And yet, to an economist, we would say. You didn't make a million dollars pursuing that choice because there are other important implicit costs of pursuing that one branch relative to the other choices before you. When you pursue the MBA now, you give up the choice to travel now. You give up the choice to work now. You give up the choice to wait for five years to pursue the MBA. So you're also giving up the potential profits with the other branches in the decision tree. How do we factor those in? You gave up all three of those other choices out of the set of four. Should we subtract them all off? The million dollars you earn in the counting terms pursuing the MBA now? No, you only subtract off the next best choice. Because resources are limited. You can only pursue one choice at a time. And so by pursuing the MBA now, what you also want to factor in is the next best option. Which is waiting five years. And so to an economist, the profit you actually end up making from pursuing the MBA now. Would be the million dollar accounting profit minus the implicit cost of 800,000 that you would have earned from your next best alternative. So, the economic profit is only $200,000. Counterintuitive but again it forces us to think through what are the options for all the resources. Including your time, and that you can only do one thing at a time. This'll give you a flavour, and again it's difficult to measure some of these explicit costs. But presumably decision makers are factoring them in when making decisions. One aside. it's interesting nowadays that most schools wait and individuals wait. The analysis that has been done here at Simon indicates for an individual prospective student. It's roughly $200,000 better to pursue the MBA earlier right out of college as opposed to later. Why have schools shifted, though to waiting for five years for the average, matricula to their MBA programs. Turns out it's rankings. institutions, such as U.S. News and Business Week appeared in the late 80s. And induced the shift, it's better for schools to look for older candidates. Especially, if you get measured on the average starting salaries of your MBA graduates. Any top school nowadays would dearly love to enroll Bill Gates, and be able to count his salary. Even though he's been out of an undergraduate program for 40 years. We would wait even longer than four years if we could attract enough candidates, but after five years post college it becomes increasingly difficult. Part time MBA programs, executive MBA, or online are better options. So it gives you a flavour for why this shift has occurred that business schools react to the same incentives. That we'll see individual consumers impact, get impacted by and we've not been immune from those incentives. Also of interest, law schools and medical schools still take people straight out of college. And of note, US News doesn't evaluate them on average starting salaries. So the incentives that have pushed top business schools to waiting for older candidates, are not in place to encourage similar behavior for medical schools and for law schools. And an interesting side note is, it hasn't helped on gender diversity. Our top business schools have actually become less gender diverse. As schools have looked toward older candidates. Becomes especially hard to attract top female candidates that are 26 to 28 years old when family decisions end up being made. But it's hard also to attract top male candidates. So just give you a flavour through this example of how we economists calculate opportunity costs. The role of explicit and implicit costs and that economic costs embody both implicit and explicit costs and only look at the next best alternative.
