Homework 1 Solution

# Homework 1 Solution - Homework#1 Name_Key Fall 2011 Due...

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Homework #1 Name_____Key____________________________ Fall, 2011 Due: Wednesday, September 7 th at the beginning of class. Directions: I prefer that you print out this document and answer the questions clearly in the spaces provided. I reserve the right to penalize sloppy or unclear answers. 1. a. Define opportunity cost. Opportunity cost is the value of the next-best alternative sacrificed when a choice is made. b. Sarah’s friends are trying to convince her to leave her summer job one month early, from which she earns \$1200 per month, to vacation in Costa Rica. If she goes there, her out-of-pocket expenses would be \$1500. What is Sarah’s marginal opportunity cost of going to Costa Rica? If the marginal benefit she gets from the vacation is equivalent to \$2500, should she go? Explain. Her opportunity cost is the out-of-pocket expenses (\$1500) plus the lost income (\$1200), for a total of \$2700. She should not go because marginal benefit < marginal opportunity cost. c. Now suppose that Sarah has already purchased the plane fare to Costa Rica, which is \$800 of the \$1500 trip cost. What is her marginal opportunity cost of the trip in this case? If her MB is still \$2500, what should she do? Explain. The plane fare expense is now sunk and doesn’t matter (assuming she can’t use the miles for another flight) Her marginal opportunity cost in this case is the remaining \$700 cost of the trip plus the \$1200 lost income, for a total of \$1900. Now she should go because Marginal Benefit

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Homework 1 Solution - Homework#1 Name_Key Fall 2011 Due...

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