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Unformatted text preview: Chapter 1 Thinking like an Economist 13 May 2011 1. The most you would be willing to pay for having a freshly washed car before going out on a date is $6. The smallest amount of which you would be willing to wash someone else's car is $3.50. You are going out this evening, and your car is dirty. How much economic surplus would you receive from washing it? Answer: In Economics, we always assume rationality, for example, you will pay $3500 for a new mobile phone because you think the new mobile phone is worth at least $3500 or the new phone will potentially bring you happiness or enjoyment that is worth at least $3500. The most you would be willing to pay for a car wash is $6 means $6 is the bene t you derived from having your car washed. You pay $6 for a car wash because you think the service is worth $6; you won't pay $6 for a type of service that you think is only worth $5. The smallest amount for which you would be willing to wash a car for someone is $3.5 means you will need to charge someone at least $3.5 for perfoming a car wash for him/her. $3.5 is just enough to compensate for your e ort and time spent on the car wash. You would be happy if someone pays you more than $3.5 for a car wash; however, you would not be willing to perform a car wash if someone pays you less than $3.5 as the price does not cover the value of your alternative activity such as an afternoon tea or an afternoon nap, etc. Cost-bene t principle says An action should be taken, if and only if, the extra bene ts from taking the action are at least as great as the extra costs From the question, we know that the bene t of of having your car washed is $6; the cost of performing a car wash (for anyone, including yourself) is $3.5. Since bene t is larger than cost, you should wash the car yourself. Economic surplus is the di erence between bene t and cost of the action, ES ( x ) = B ( x )- C ( x ) = 6- 3 . 5 = $2 . 5 This kind of question about whether we should do an activity x is di cult because we are not used to comparing the bene t of doing the acitivity and the cost of doing so, all by ourselves. Some of us are more used to thinking of an exchange with another person. In this case, consider the following slightly di erent story. The most you would be willing to pay for having a freshly washed car before going out on a date is $6. The kid next door washes cars at a price of $3.5 per car. Should you hire him to wash the car? Yes, by doing so, you get an economic surplus of $2.5. This situation becomes the same as the original situation when we make you the kid . 2. To earn extra money in the summer, you grow tomatoes and sell them at the farmers' market for 30 cents per pound. By adding compost to your garden, you can increase your yield as shown in the table below. If compost costs 50 cents per pound and your goal is to make as much money as possible, how many pounds of compost should you add?...
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