221Graded1 - Econ 221 Graded Homework 1 This assignment is...

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Econ 221 Graded Homework 1 This assignment is worth 64 points. It is due in class on the day of Exam 1. Please adhere to my guidelines which are posted on WebCT under “Course Content”. Failure to do will result in a penalty. 1. Opportunity Cost (2 pts.) Your friend is preparing for an exam and in the review session makes the following statement: "Instead of attending microeconomics class for two hours, Kiki could have played tennis or watched a movie. Therefore, the opportunity cost of attending class is the tennis and the movie she had to give up." Is your friend's analysis correct or not? Explain your answer. No, she is incorrect. Opportunity cost is the cost of the highest valued alternative foregone, so the cost of attending class is not both tennis and the movie she gave up, but rather whichever one had the most value based on whatever system Kiki decided to use. 2. Incentives (2 pts.) Consider the following summary of a WSJ article. The number of people involuntarily bumped off flights bounced up more than 40% to 185,368 in the second quarter, compared with the same period in 2005, according to government data. Also, the number of passengers enticed to voluntarily give up seats on overbooked flights rose more than 10% in the second quarter over last year." The reason for the increase in overbooked flights: Higher fuel prices. With the increased marginal cost of flying planes, airlines have cut back on the number of flights, thus jamming more people onto remaining trips. Furthermore, airlines have the financial incentive to overbook flights. "The DOT requires that airlines compensate passengers for bumping them off flights, but the maximum amount of $400 was set in 1978 and hasn't changed. Had the maximum amount been adjusted for inflation, it would be more than $1,200 today. And some argue that since the last tickets sold are usually more expensive, airlines have too much incentive to sell $1,000 tickets when no seats are available if the penalty is only $400 to bump a cheaper-fare passenger. Source: “More Fliers Forced to Give Up Seats”, by Scott McCartney, Oct 10, 2006, Wall Street Journal, Page D.1 Why does the policy of airlines paying bumped flyers $400 encourage airlines to overbook flights? (No more than 3 choice sentences, please. Use economic concepts and terms. Airlines have the positive incentive to bump passengers off flights because their marginal return is greater than their marginal cost. Here, the cost is $400 for the bumped passenger, but they are able to sell that passenger’s seat to another person for $1000, giving them a profit of $600. Because prices have not been adjusted for inflation over the years they are able to accrue a hefty profit while keeping bumped passengers happy because they are given $400 that they did not have before, and the potential new passengers happy with seats on the flight. 3.
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This note was uploaded on 05/10/2010 for the course ECON 221 taught by Professor Ramoo during the Spring '10 term at Diablo Valley College.

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221Graded1 - Econ 221 Graded Homework 1 This assignment is...

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