Key, Graded Homework 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.
Your friend's analysis is incorrect. The opportunity cost of an action is the highest-valued
alternatives forgone. Kiki's opportunity cost of studying for her exam is either
the tennis or the movie, whichever she would have done had she not studied.
2. Incentives (2 pts.)
Consider the following summary of a
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
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 receive a
of $1,000 for the last tickets sold whereas the
of bumping a passenger to accommodate the last passengers is $400, resulting in
a net marginal
of $600. As such, it gives airlines incentive to overbook flights.
Opportunity Cost (2 pts.)
Baseball's New York Yankees allow season-ticket holders to electronically forward tickets to a charitable
organization, Big Brothers and Big Sisters of New York City. The processing fee is waived. Suppose the
price of a ticket is $150. What is the opportunity cost to the ticket holder who donates her ticket to the
charity in the following 2 cases: where a ticket holder (i) can sell the ticket, and (ii) cannot sell the ticket.
Keep things simple, do not worry about tax treatments.