Microeconomics Solutions

Microeconomics Solutions - Chapter 1 THINKING LIKE AN...

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Chapter 1 THINKING LIKE AN ECONOMIST Boiling Down Chapter 1 1. The full cost (opportunity cost) of an action is underestimated because some costs come in the form of opportunities sacrificed rather than dollars paid or in the form of social cost not borne by the decision maker. 2. Some costs are going to be paid whether an action is undertaken or not. These sunk costs are thus not relevant to the choice at hand and to count them in the cost assessment of a decision is to overestimate cost. There are times when emotion connects a past sunk cost with a present decision so that people make choices that are at variance with economic principles. Examples in the text in- clude the decision to eat less pizza because of a nice gesture from the owner or the decision to stay home from the concert when a storm occurs because the ticket was given instead of purchased. 3. The absolute value of a cost or benefit is skewed by its proportion of the total cost or benefit being considered. The WalMart example in the text illustrates how differently people might consider a $10 saving depending on the size of the purchase. 4. In considering whether to increase some activity, like launching boats in the text example, it is common to count the average cost of the additional act rather than the marginal cost, which is an accurate measure of the added costs. Effi- cient decision making occurs when marginal benefits equal marginal costs. This assumes that each person pursues what they believe is in their best interest. Adam Smith argued that if people do this in a morally appropriate way resources will flow to their best use as if guided by an invisible hand. He did, however, have much to say about why, in a social system, there is need for considerable qualification of this principle. Chapter Outline 1. Microeconomics is the study of how people choose under conditions of scarcity. a. If the benefits of an alternative outweigh the costs, that alternative is chosen. b. Economic models are designed to help predict what choices will be made. 2. Decisions to proceed are made when the benefits of doing something exceed the costs of doing it. a. The costs and benefits must be the full opportunity costs and benefits. b. The calculations are usually unconscious or not thought of as explicit calcu- lations. People simply behave as if they make the calculations. 3. Choices are often made incorrectly because of common pitfalls in thinking. a. People tend to ignore implicit opportunity costs. b. People consider sunk costs that should be ignored.
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CHAPTER 1: Thinking like an economist c. The mind tends to see things as proportions of the whole rather than in abso- lute dollar amounts. d. Marginal analysis rather than consideration of averages is essential to good decision making when one is considering changes because the costs and be- nefits that really matter are those at the margin. 4.
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Microeconomics Solutions - Chapter 1 THINKING LIKE AN...

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