Assume that an individual has to choose between two options: buying a mobile phone, or buying an iPod. The expected cost of buying a phone is $700 and the expected benefit is $900

Question

The expected cost of buying an iPod is $300, and the expected benefit is $600. How does the individual arrive at the optimal choice if he implements: a) optimization in levels? b) optimization in differences?

Answer 1

a) The process of optimization in levels will require the comparison of net benefit of both the available options. This is shown as follows:
Net benefit of buying a phone = $900 - $700 = $200.
Net benefit of buying an iPod = $600 - $300 = $300.
Because net benefit of an iPod exceeds the net benefit of a mobile phone, optimization in levels will suggest buying an iPod.

b) The process of optimization in differences will require the estimation of the change in net benefit when an individual shifts from one alternative to another. This is shown as follows:
Change in net benefit if the individual chooses to buy an iPod over a mobile phone = $300 - $200 = $100, which is positive. On the other hand, change in net benefit if the individual chooses to buy a phone over an iPod = $200 - $300 = -$100, which is negative. Hence, optimization in differences will suggest buying an iPod.