Wendy has to decide between taking a flight and driving to California. Air tickets cost $800 and will get her to California in 2 hours. If she decides to drive, she would need $300 worth of gasoline and 10 hours to reach her destination

Question

Suppose that Wendy's opportunity cost of time is $20 per hour. Assuming that there are no other costs involved, use cost-benefit analysis to decide whether she should fly or drive to California. If Wendy has an important business meeting to attend and this increases her opportunity cost of time to $200 per hour, will her optimum decision change? Explain.

Answer 1

Cost-benefit analysis is a calculation that adds up costs and benefits using a common unit of measurement. It is used to identify the alternative that has the greatest net benefit, which is equivalent to benefits minus costs.
If Wendy decides to drive down instead of flying, she saves ($800 - $300 ) = $500. But driving down to California takes an additional 8 hours of travelling time.
Therefore, the net benefit of driving relative to flying = ($500 cost saving) - (8 hours of additional travelling time) × ($20/hour) = $500 - $160 = $340.
Because the net benefit of driving is positive, driving to California is an optimum choice for Wendy when the opportunity cost of time is $20 per hour.
If the opportunity cost of time changes, the net benefit of driving relative to flying will also change.
Net benefit of driving relative to flying when the opportunity cost of time is $200 per hour = ($500 cost saving) - (8 hours of additional travelling time) × ($200/hour) = $500 - $1,600 = -$1,100.
Because the net benefit of driving relative to flying is negative, flying to California is an optimum choice for Wendy when the opportunity cost of time is $200 per hour.