Answers to Text Questions and Problems, Chapter 1

Transcription

1 1 of 9 1/3/2010 2:31 PM Answers to Text Questions and Problems, Chapter 1 Answers to Review Questions 1. Your friend probably means that your tennis game will improve faster if you take solo private lessons instead of group lessons. But private lessons are also more costly than group lessons. So those people who don t care that much about how rapidly they improve may do better to take group lessons and spend what they save on other things. 2. Sam s decision could be rational if the shop he chose has, say, a more convenient location or a better reputation for standing behind its products, and he considers these advantages to be worth the extra $ False. Your willingness to make the trip should depend only on whether $30 is more or less than the cost of driving downtown. 4. Because the price of a movie ticket is a cost the patron must pay explicitly, it tends to be more noticeable than the money that she would fail to earn by seeing the movie. As Sherlock Holmes recognized, it s easier to notice that a dog has barked than that it has failed to bark. 5. Using a frequent flyer coupon for one trip usually means not having one available to use for another. Thinking of frequent flyer travel as free therefore leads people to take some trips that they shouldn t. 6. Suppose you put $10 million in the bank today and left it there to earn interest for the next ten years. The amount you d have in your account at the end of 10 years would be much greater than if you put $1 million a year into the same account for the next ten years. 7. If your tuition payment is nonrefundable, it is both a sunk cost and a fixed cost. If the payment is refundable, it is a fixed cost but not a sunk cost. Answers to Problems 1a. If the marginal cost drops to $150, then 2 gigabytes is no longer the optimum amount of memory to install, as the marginal cost is now less than the marginal benefit. Instead, it would be optimal to continue installing memory as long as the marginal benefit exceeds the marginal cost, and to stop when marginal benefit equals marginal cost. This occurs at 4 gigabytes of memory. b. The marginal benefit curve will shift to the right. At the initial amount of memory, the marginal benefit will now

2 2 of 9 1/3/2010 2:31 PM exceed the marginal cost, so it will be optimal to install more memory. c. A fall in the marginal cost and a rise in the marginal benefit alone will each raise the optimum amount of memory to install. Together, the effect will be a huge increase in the amount of memory installed on new computers. 2. The economic surplus from washing your dirty car is $6 minus $3.50, or $ The benefit of adding a kilogram of compost is the extra revenue you ll get from the extra tomatoes that result. The cost of adding a kilogram of compost is 50 cents. By adding the fourth kilogram of compost you ll get 2 extra kilograms of tomatoes, or 60 cents in extra revenue, which more than covers the 50-cent cost of the extra kilogram of compost. But adding the fifth kilogram of compost gives only 1 extra kilogram of tomatoes, so the corresponding revenue increase (30 cents) is less than the cost of the compost. You should add 4 kilograms of compost and no more. 4. For a seven-minute call, the two phone systems charge exactly the same amount, 70 cents. But at that point under the new plan, the marginal cost is only 2 cents per minute, compared to 10 cents per minute under the current plan. And since the benefit of talking additional minutes is the same under the two plans, Tom will make longer calls under the new plan. 5. In University A, everybody will keep eating until the benefit from eating an extra kilogram of food is equal to $0, since that is the extra cost to them for each extra kilogram of food they eat. In University B, the cost of eating an extra kilogram of food is $4, so people will stop eating when the benefit of eating an extra kilogram falls to $4. Food consumption will thus be higher at University A. 6. In the first case, the cost is $6 per week no matter how many cans you put out, so the cost of disposing of an extra can of garbage is $0. Under the tag system, the cost of putting out an extra can is $2, regardless of the number of cans. Since the relevant costs are higher under the tag system, we would expect this system to reduce the number of cans collected. 7. At Smith s house, each child has an incentive to consume rapidly to prevent the other from encroaching on his share. Jones, by contrast, has eliminated that incentive by making sure that neither child can drink more than half the cans. This step permits his children to consume at a slower, more enjoyable pace. 8. If Tom kept the $200 and invested it in additional mushrooms, at the end of a year s time he would have an additional $400 worth of mushrooms to sell. Dushan must therefore give Tom $400 in interest in order for Tom not to lose money on the loan. 9a. John s economic surplus from the additional memory is equal to $55 $48 = $7. b. Suppose that John benefited by $10 from the first additional gigabyte but by only $1 from the 64 th additional gigabyte. Then the marginal benefit of adding the 64 th megabyte would be less than its $4 cost. In this case, the

3 3 of 9 1/3/2010 2:31 PM statement is false: John should not have added more memory; in fact, he should have added less. 10a. The average cost of a shirt is the total cost of producing all the shirts divided by the number of shirts produced. In this case, the total cost of producing all the shirts is $ ($8), which comes to $17,000. Therefore, the average cost of a shirt is $17,000/2000 = $8.50. b. The marginal cost of a shirt is $8. c. The average cost of a shirt is now [$ ($8)]/3000 = $25,000/3000, or $8.33. d. The marginal cost is still $ The lowest price at which you would be willing to sell your lottery ticket today is $400, because if you put that amount in your bank account today at 6 percent interest, it will be worth $424 one year from now. 12. The total cost of the bus trip is $670. However, the driver s fee and the $100 cancellation charge are sunk costs, whereas the remaining $475 are variable costs that will be incurred only if the trip takes place. Just chartering the bus therefore costs $195, and since there is always the risk that few people will want to go, the relevant decision is how to prevent the potential loss from rising above $195. Since variable costs are avoidable by cancellation, those variable costs at least should be covered if the trip is to take place. At $25 per ticket, at least 19 people must sign up for the trip a week in advance to cover the variable costs. 13. By selling Mikkel the Trek, Sam would be giving up the Trek to spend $200 more on a Cannondale. But we know that the Cannondale is not worth $200 more to Sam than the Trek or else he would have bought the Cannondale for $1000 in the first place. So Sam should keep the Trek. 14. Beforehand, the cost of attending the Shania Twain concert ($50 for the bus ticket) was the same as for the Tragically Hip concert ($50 for the concert ticket). From the fact that Courtney would have chosen Tragically Hip had she known about both events in advance, we know that her benefit from seeing Tragically Hip must be higher than her benefit from seeing Shania Twain. Having purchased the bus ticket and with a free Tragically Hip ticket in hand, she faces no additional costs of attending either event. So she should attend Tragically Hip s performance, the one for which her benefit is higher. 15. False. Let the benefit from attending the concert be B(C) and the benefit from attending the fireworks display be B(F). Since Mandy and Tomas have identical tastes, B(C) and B(F) will be the same for both of them. For Mandy, the concert ticket represents a sunk cost, so the marginal cost of going to the concert is now zero. So she should go to the fireworks display if B(F) > B(C). However, for Tomas, the marginal cost of going to the concert is still $20. So Tomas should go to the fireworks display if B(F) > B(C) $20, his net benefit of going to the concert. The two might therefore differ in their decisions, but not necessarily. For example, if B(F) were $100 and B(C) were $95, they would both go to the fireworks display. 16a. This statement is an example of the fallacy of composition. Policies that are good for business are not

4 4 of 9 1/3/2010 2:31 PM necessarily good for the rest of the country. b. This statement is an example of the fallacy of composition. While the Olympics will generate tourism revenue, it is not possible to say that the entire city will be made better off. c. This statement is an example of the post hoc fallacy. It is possible that the sex education programs were introduced in schools that had higher rates of sexual activity in the first place. d. This statement is an example of the post hoc fallacy. Unless there is a theory that establishes cause and effect, the fact that people who smoke are at greater risk of developing lung cancer than are non-smokers is not sufficient evidence to prove that smoking increases the risk of lung cancer. e. This statement is an example of the fallacy of composition. If all farmers produce bigger crops, prices will fall, and farmers will not necessarily be better off. f. This statement is an example of the fallacy of composition. While steel shareholders and steel workers will be better off, the increased price of steel will make others worse off, so it is not possible to say that the entire population is better off. g. This statement is an example of the fallacy of composition. While those who are lactose intolerant are better off not consuming dairy products, there is no health reason for others to avoid dairy products. Sample Homework Assignment 1. You decide to purchase a one-year, non-refundable membership to a fitness centre for $500. You plan to work out twice a week for 50 weeks during the year. a. If you do as you plan, what is the average cost of a visit? b. If you decide to work out a third time each week during the year, what is the marginal cost of the third visit each week? c. After the first week, you realize that you hate to work out. What is the optimal number of workouts for the remainder of the year to maximize your enjoyment? 2. You have decided to open your own fruit stand. To do so, you have to pay $200 for the stand and $100 per month to rent a space. The wholesale price of fruit is $0.25 per kilogram. To hire an assistant you need costs $5 per hour. If you open the stand for a month (twenty 8-hour days) and sell 1000 kilograms of fruit per day, find each of the following: a. Total cost, total fixed cost, total variable cost, and average cost per kilogram (for the month). b. The marginal cost of a kilogram of fruit. c. The opportunity cost of opening the stand for a month. Assume that, if you didn t open the fruit stand, you could manage a yogurt shop and make $10 per hour. 3. You receive a $500 birthday cheque, but have no plans to spend the money until your next birthday. Your bank

5 5 of 9 1/3/2010 2:31 PM pays you 10% interest on your deposits. If friends borrow your $500 for the year, and want to leave you as well off as if they hadn t borrowed the money, how much would they have to pay you on your next birthday? Multiple Choice Quiz 1. Which of the following would eliminate the need for economics? a. Unlimited wants b. Limited needs c. Unlimited resources d. Limited resources e. Unlimited needs 2. The Scarcity Problem implies that having more of one thing usually means a. increasing resources. b. limiting wants. c. increasing the need for another. d. having less of another. e. having more of another. 3. The Cost-Benefit Principle tells people that they should take an action if a. benefits equal costs. b. costs exceed benefits. c. marginal costs exceed marginal benefits. d. marginal benefits exceed marginal costs. e. benefits are positive. 4. People who have well-defined goals and try to fulfill those goals as best they can are known as a. rational. b. macroeconomists.

6 6 of 9 1/3/2010 2:31 PM c. microeconomists. d. maximizers. e. opportunists. 5. The benefit of a good is a. the lowest price for which you can get it. b. the amount you would pay to get on a waiting list. c. the highest price you would pay for it. d. the price you pay to buy it. e. equal to the market price. 6. The time value of money tells you that a. a dollar received in the future is worth less than a dollar received today. b. a given dollar amount today is equivalent to a smaller dollar amount in the future. c. charging interest on a loan is not fair. d. the opportunity cost of loaning money is equal to the interest rate. e. the opportunity cost should not always be considered when performing a cost-benefit analysis. 7. A sunk cost is a. the value of money put into an investment. b. beyond recovery at the moment a decision must be made. c. important to consider when conducting cost-benefit analysis. d. equal to the opportunity cost when the interest rate is zero. e. the same as a marginal cost. 8. When deciding whether to pursue an activity further, which of the following costs are relevant? a. Sunk costs b. Marginal costs c. Average costs

7 7 of 9 1/3/2010 2:31 PM d. Total costs e. Opportunistic costs 9. A cost that is beyond recovery at the moment a decision must be made is called a(n) a. average cost. b. marginal cost. c. opportunity cost. d. total cost. e. sunk cost. 10. To allocate resources efficiently across different activities, each unit of the resource should be allocated to the activity in which its is highest. a. marginal cost b. average cost c. marginal benefit d. average benefit e. total benefit Problems/Short Answer 1. The meal plan at a university lets students eat as much as they like for a $600-per-semester fee. The university is considering changing to a meal plan that charges students $600 for a book of meal tickets that entitles them to eat 200 kilograms of food per semester. Under the new plan, if students eat less, they get refunds and if they eat more, they must pay extra. a. What is the marginal cost of food under the existing plan? b. What is the marginal cost of food under the new plan being considered? c. Under which plan will food consumption be highest? Explain. 2. You decide to spend your spare time selling t-shirts with your university logo at events on campus for a month. To do this, you buy a machine for $250, 100 blank t-shirts (for $4.50 each) and 100 logos to put on the t-shirts (for $1.00 each). Based on this information, answer each of the following. a. What are your total costs, total fixed costs, total variable costs, and average cost per t-shirt?

8 8 of 9 1/3/2010 2:31 PM b. If selling t-shirts for the month requires quitting your university bookstore job (where you earn $500 per month), what is your opportunity cost of selling t-shirts? How much would you have to sell all your t-shirts for in a month for it to be an efficient choice? Answer Key to Extra Questions in Instructor s Manual Sample Homework Assignment 1a. $500/(2 50) = $500/100 = $5. b. It costs nothing extra to work out a third time each week, so MC = 0. c. Since MB = 0 (you hate to work out), then you shouldn t work out at all. The $500 is a sunk cost and should be ignored. 2a. TC = $200 + $ ($ ) + 20 ($5 8) = $300 + $ $800 = $6100. TFC = $200 + $100 = $300. TVC = $ $800 = $5800. AC = TC/Q = $6100/( ) = $6100/20,000 = b. MC = $0.25. c. Opportunity cost = 20 ($10 8) = $ The value of $500 in one year, if it is deposited in the bank at 10% interest, is $ = $550. Multiple Choice 1. c 2. d 3. d 4. a 5. c 6. a

9 9 of 9 1/3/2010 2:31 PM 7. b 8. b 9. e 10. c Problems/Short Answer 1a. Zero. b. $600/200 kg = $3/kg. c. Under the old plan. Students will eat until MC = MB. They eat until MB = 0 under the existing plan because MC = 0 and until MB = $3 under the new plan because MC = $3 ($600/200). Since MB declines as more is consumed, they eat more under the old plan. 2a. TC = $250 + $450 + $100 = $800. TFC = $250. TVC = ($ ) + ($ ) = $450 + $100 = $550. AC per t-shirt = TC/Q = $800/100 = $8.00. b. Your opportunity cost is $500. You must sell the 100 t-shirts for at least your average cost (including the opportunity cost): $1300/100 = $13.00.