Ps01_sol - ECON1001 ECON1001 Answer to Answer Exercise#1 Exercise Q.1 The scarcity principle implies that to have more of one thing usually means a

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Unformatted text preview: ECON1001 ECON1001 Answer to Answer Exercise #1 Exercise Q.1 The scarcity principle implies that to have more of one thing usually means a. b. c. d. e. increasing resources limiting wants increasing the need for another having less of another none of the above Answer: d by definition Option a: if resources can be increased whenever we’ve scarcity, there’ll be no need to study economics! Option b: come on!! Admit it! Human wants are unlimited! Option c: If you need to increase your desire on B while you’re having more A… you’re facing a more severe ‘scarcity’ problem. Q.2 A sunk cost is Q.2 A sunk cost is a. b. c. d. e. the value of money sunk into investment beyond recovery at the moment a decision must be made important to consider when conducting cost­benefit analysis equal to the opportunity cost when the interest rate is zero the same as a marginal cost Answer: b definition (option d does not make sense, designed to confuse you.) E.g. From lecture: You are late on a date with your girlfriend/boyfriend. What will you do while on the bus? as usual, enjoying your music or Nds? Very frustrated, worried? Can you do anything at this moment for not being late? Q.3 When deciding whether to pursue an Q.3 When deciding whether to pursue an activity further, which of the following cost is relevant? a. b. c. d. e. sunk costs marginal costs average costs total costs fixed cost Answer: b By definition, By Cost-benefit principle tells us that in deciding Cost-benefit whether to further an activity, we should consider its MB and MC, and, if and only if, MB>MC. MB>MC. KEY: When deciding whether to pursue an activity further… Further = additional Sunk cost: NOT recoverable at the moment you make the decision, i.e. not relevant in deciding whether to pursue an activity further… E.g. Isaac, who is the hottest guy among freshmen, asked you out AFTER one of the following situations: i. you’ve purchased a non­refundable $40 movie ticket. ii. you’ve purchased a non­refundable $2000 Madonna world tour concert ticket Assuming that the value of going out with Isaac is the highest among the 3 activities, Will there be any differences in your choice under the two situations? Q.4 Suppose the most you would be willing to Q.4 Suppose the most you would be willing to pay for a plane ticket home is $250, but you buy one online for $175. The economic surplus of buying the online ticket is: a. b. c. d. e. $175. $250. $75 $50. $0. Answer: c econ surplus = benefit – cost The economic surplus of buying the online ticket = willingness to pay – price Willingness to pay reflects how much you could benefit from the action Econ surplus = $250 ­ $175 = $75 Q.5 In general, rational decision making Q.5 In general, rational decision making requires one to choose the actions that yield the a. b. c. d. e. largest total benefit. smallest average cost. smallest total cost. largest economic surplus. smallest net benefit. Answer: d Economists ADOPTED the Cost­Benefit Analysis in analyzing human behavior Thus, to know how action/behavior will change under different circumstances, we need to calculate BOTH cost AND benefit i.e. we consider ‘net benefit’/ ‘econ surplus’ definition: econ surplus = benefit ­ cost Q.6 If each unit costs $12, and you can only buy Q.6 If each unit costs $12, and you can only buy whole units, what is the optimal quantity to purchase? Q 1 2 3 5 7 MB($) 20 15 10 5 0 a. b. c. d. e. 1 2 3 5 6 Answer: b * MB = Marginal Benefits P=$12/unit (CONSTANT price no matter how many you buy ) The seller sells ONE UNIT BY ONE UNIT Define: Economic Surplus = Benefit – cost If you purchase the good one unit by one unit, THAT unit’s econ surplus = MB ­ $12 Unit 1: $20 ­ $12 = $8 Unit 2: $15 ­ $12 = $3 … Thus, the optimal quantity to buy is 2units Will you buy the 3rd unit? Q 1 2 3 5 7 MB($) Surplus($) 20 15 10 5 0 8 3 ­2 ­7 ­12 Now assume the seller sells them in PACKAGES, while unit price is constant… Additional challenge Additional challenge If the good is sold in packages: Package of ONE unit TOTAL ECON SURPLUS = MB ($20) – cost ($12) = $8 Package of TWO units TOTAL ECON SURPLUS = MB 1st unit + MB 2nd unit – $12X2 = $11 Calculate all 7 packages Which package should you buy? Q.7 What would price have to equal before 7 units Q.7 What would price have to equal before 7 units would be purchased? If each unit costs $x, and your optimal quantity to purchase is 7. What is $x? Q 1 2 3 5 7 MB($) 20 15 10 5 0 a. b. c. d. e. 0 5 10 15 20 Answer: a How much will you pay for each unit if the seller How much will you pay for sells them to you one by one ? Q 1 2 3 5 7 MB($) 20 15 10 5 0 e.g. $25 for 1st unit? or $19 for 1st unit? $18 for 2nd unit? or $14.5 for 2nd unit? : : $0.000001 for 7th unit? or 0 for 7th unit? Marginal Benefit Additional benefit for having ONE MORE UNIT = max amount of money you’re willing to pay for having the additional unit Note: just an econ concept, NOT directly observable, but may be estimated. So don’t blame you Sociology classmate for not knowing the term in making a purchase decision AND, her purchase decision will NOT be irrational/ invalid in economics because she doesn’t understand the term ‘MB’. Although most people do not know the term, they behave as if they are comparing marginal benefits to marginal cost in making their decisions. Q.8 Amy is thinking about going to the movies Q.8 tonight. A ticket costs $7 and she will have to cancel her dog­sitting job that pays $30. The cost of seeing the movie is a. b. c. d. e. $7. $30. $37. $37 minus the benefit of seeing the movie. indeterminate. Answer: c Opportunity Cost = Value of best alternative forgone Amy has to forgo i. $7 ii. One evening Oppo. Cost for Amy to go movie = $7 + ‘value of one evening’/’value given by dog sitting’ Oppo. Cost for Amy to go movie = $7 + ‘value of one evening’/’value given by dog sitting’ = explicit cost + implicit cost (implicit = not directly observable) = money cost + time cost Q.9 Jody has purchased a non­refundable $25 ticket to Q.9 Jody has purchased a non­refundable $25 ticket to attend a Savage Garden concert on Friday evening. Subsequently, she is asked to go to dinner and dancing at no expense to her. If she uses cost­benefit analysis to choose between going to the concert and going on the date, she should a. b. c. d. e. include only the entertainment value of the concert in the opportunity cost of going on the date. include the cost of the ticket plus the entertainment value of the concert in the opportunity cost of going on the date. include only the cost of concert ticket in the opportunity cost of going on the date. include neither the cost of the ticket plus the entertainment value of the concert in the opportunity cost of going on the date. have a psychiatric evaluation because dates cannot be evaluated using cost­benefit analysis. Answer: a DECISION: Concert VS Date Oppo. Cost of going concert = give up ‘net’ economic surplus of date = value of date – expected expenses of date = ‘value’ – zero (‘dancing at no expense to her’) Oppo. Cost of going date = give up ‘net’ economic surplus of concert = value of concert – expected expenses of concert = ‘value’ – ?????? $25??? SHOULD YOU PUT IN THE COST OF TICKET!? ($25) SUNK COSTS are costs that ­ have already been incurred ­ cannot be recovered at that moment when you’re making decisions Does that ‘$25’ fit in the above definitions? THEREFORE Oppo. Cost of going date = give up ‘net’ economic surplus of concert = value of concert – expected ADDITIONAL expenses of concert = ‘value’ – zero Try to analyze the question AGAIN by using MARGINAL Value/Cost IF the ticket is fully refundable, how would it affect Jody’s decision? IF the ticket is refundable at a discounted price, how would it affect Jody’s decision? Q.10 If the government wanted to use the Q.10 If the government wanted to use the incentive principle to discourage smoking, it would a. b. c. d. e. publicize the health risks associated with second­hand smoke. increase taxes on cigarettes, raising the price of a pack. subsidize tobacco companies. subsidize hospitals for treating lung disease. invest more money in health research. Answer: b An Incentive is a reward that encourages or a penalty that discourages an action. Most DIRECT way to reduce smoking: Raise Price of cigarettes DISCOURAGE CONSUMPTION Can be done by option b: impose tax on producers = increase production costs the market needs a higher market price to support the production (common sense argument) Option c & d: contradict to answer C: subsidize tobacco companies encourage productions D: subsidize hospitals for treating lung disease. lower opportunity cost to smoke, encourage consumption Option a & e: also discourage smokers but results NOT as direct as imposing taxes on producers reduce production + consumption End End ...
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This note was uploaded on 09/06/2010 for the course FBE ECON1001 taught by Professor Dr.demurger during the Fall '08 term at HKU.

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