Your student association is looking for an auditorium to rent for an all-day conference. The university's Performing Arts Center is vacant on that day, so the association wants to rent it

Question

The physical plant manager tells you that the daily rent is $660, which includes $400 to cover part of the cost paid to build the Center, $40 to cover part of its regular maintenance cost, $50 to help pay for the building's insurance, $100 to cover the extra cost of electricity that the university would incur because of the conference, and $70 to pay for additional janitorial services for the conference. You know that no one else wants to rent the Center on that day and you think that the price that the manager charges is too high. But how much should you pay? Use the economic way of thinking to answer this question and to convince the manager to accept your offer: a) If you rent the Center, what will be the university's marginal cost of renting the center to you? b) If you rent the Center, what will be the university's marginal benefit of renting the center to you? c) What amount of rent should you offer? Convince the manager to accept your offer.

Answer 1

a) The university's marginal cost is $170. These are the extra cost of electricity ($100 ) and janitorial services ($70 ) that the university will only pay if you rent the Center. The costs of building the Center, insurance, and regular maintenance costs are not extra costs incurred because you rent the Center. The university has already paid for building it and pays the cost of insurance and regular maintenance no matter whether you rent the Center or not. Therefore these costs are not marginal costs of renting the center to you.
b) The university's marginal benefit is the amount of rent that you pay.
c) You should start negotiating from $171. Because the university's marginal cost is $170 and the amount you pay is its marginal benefit, the university will be better off if it accepts any amount greater than $170. If the manager is still not convinced, tell the manager that, since no one else wants to rent the Center on that day, declining your offer is not cost free. The opportunity cost of not accepting it will be the difference between the offered rent and $170. In practice, of course, there are transaction costs, such as the time spent by both parties to negotiate and sign the agreement, and accepting your offer will cost the manager some extra time and organizational effort. Also, as you learnt in this chapter, people are guided by self-interest when they make their decisions and the manager's self-interest is not necessarily the same as the university's interest. On the other hand, you might want to support your university. Therefore the amount of rent you will agree upon is likely to be higher than $171.