Unit 1 Microeconomics Midterm: Fall 2020

(1B): Which of the following decisions would not be part of microeconomics?

(1B): Whether the federal budget should always be balanced.

(1A) Explain why the concept of scarcity is important to the study of economics.

(1A) Consumers have unlimited wants. However, there are not enough resources on this planet to fulfill every want of every person. This is scarcity - the economic situation in which our resources fail to satisfy all our wants. Therefore, scarcity means making rational decisions as to where we should allocate resources in order to produce efficiently and satisfy as many consumer wants as possible. Rational decisions always involve a choice of one product or service over another.

(1A) A recent Wall Street Journal headline read, "Hot Job Market May Melt Teen's Plans for College." The article describes falling unemployment rates for teenagers and a "negative side-effect: Fewer kids may choose to attend college." Use the concept of opportunity cost to explain why.

(1A) If the probability of getting a job is greater, than the opportunity cost of the amount of income that one could earn if he or she did not go to college is greater. Thus, with a greater opportunity cost, some teenagers will be less likely to go to college. In fact, some colleges experience significant fluctuations in enrollment as unemployment rates change.

(1A) The U.S. government is evaluating a project to build a new lighthouse in South Carolina. The cost will be $5 million. The estimated value of all the benefits (including non-monetary benefits) of the lighthouse is $8 million. Describe how you would use the concept of opportunity cost to determine whether the lighthouse should be built?

(1A) The total benefits should be compared to the total cost - money plus opportunity cost. The opportunity cost is the value of the best forgone alternative. The opportunity cost in this example will be the net benefits from the next best alternative project. If the money plus opportunity costs are more than $8 million, the lighthouse should not be built.

(1A): What is the opportunity cost of a small business investing $1 million in a new project that will pay back $1.5 million in one year? The firm's goal is to end the year with the most assets possible. Its other alternatives are: I. Leave $1 million in a bank account and earn $50,000 in interest. II. Invest $1 million in new equipment that will have a value of $1 million at the end of the year and have earned an additional $100,000 in profits during the year What is the opportunity cost of the new project?

(1A): $1,100,000 --> The value of the best alternative is $1,100,000.

(1A): The making of the movie Waterworld cost a total of $180 million. It generated a total of $130 million in revenues. $70 million was spent and then the set sank. An additional $60 million was spent to rebuild the set. An additional $50 million was spent to finish the movie. Losses for the producers of Waterworld, if they finished the movie would be _____. If they did not finish the movie, losses would be _____.

(1A): $50 million; $70 million. --> If they made the movie, total revenues would be $130 million and total costs were $180 million for a loss of $50 million. If they did not make the movie, revenue would be zero and costs would be $70 for loss of $70 million.

(1A): The making of the movie Waterworld cost a total of $180 million. It generated a total of $130 million in revenues. $70 million was spent and then the set sank. An additional $60 million was spent to rebuild the set. An additional $50 million was spent to finish the movie. The sunk cost, once the movie set sank, was _______.

(1A): $70 million --> The cost of the old set was literally sunk, but also in an economic sense. Once the set sank (and presumably could not be recovered) it had no alternative use and thus was irrelevant to the decision to film the movie.

(1A): If the benefits (correctly defined) of a doing something are greater than the costs (correctly defined) of doing whatever it is, what should one do?

(1A): Always do it --> If the benefits of doing something else are greater, then that will be added as opportunity cost of this activity. That will tend to make the cost of this activity to be greater than the benefits.

(1A): Tonight I can either (1) go out to dinner and a movie, or (2) cook dinner for some friends, or (3) eat a hamburger at the baseball game. I prefer to do (1), then (2), and finally (3) if I can only do one. If these are my best choices and the dollar cost of each is the same, what would be the opportunity cost of my going out to dinner and a movie?

(1A): Cooking dinner for some friends --> Since you prefer (1) to (2) and prefer (2) to (3), by choosing (1) you would be giving up your next best option (2).

(1A): Suppose your parents inherit your grandparents' house. They decide to move into the house and sell your current house. They did so because the house was free. Good decision?

(1A): Not a good decision, based on the assumption that it is free. It is not free. --> The house is not free. They could sell it and have that money. The price they could get for the house is part of the cost of living there.

(1A): The making of the movie Waterworld cost a total of $180 million. It generated a total of $130 million in revenues. $70 million was spent and then the set sank. An additional $60 million was spent to rebuild the set. An additional $50 million was spent to finish the movie. Should they have rebuilt the set and finished the movie?

(1A): Yes, it was rational --> 70 million dollars was a sunk cost and therefore was not relevant to the decision to film the movie. The decision to film the movie should have been based only on marginal cost and marginal benefit. The marginal cost was $110 million ($60 million to rebuild the set and $50 million to finish filming the movie) and the marginal benefit was $130 million, $20 million larger than the marginal cost.

(1B): You had to pay $600 (non-refundable) for your meal plan for Fall semester which gives you up to150 meals. If you eat only 100 meals, your marginal cost for the 100th meal is

(1B): $0

(1B): You paid $35 for a ticket (which is non-refundable) to see JAM, a local rock band, in concert on Saturday. (Assume that you would not have been willing to pay any more than $35 for this concert.) Your boss called and she is looking for someone to cover a shift on Saturday at the same time as your concert. You will have to work 4 hours and she will pay you time and a half, which is $9/hr. 10. What is your economic surplus if you go to work on Saturday?

(1B): $1

(1B): The total cost of a 700 Mhz computer is (PICTURE NEEDED)

(1B): $1,000.

(1B): The total benefit of an 800 Mhz computer is (PICTURE NEEDED)

(1B): $1,900.

(1B): Larry was accepted at three different graduate schools, and must choose one. Elite U costs $50,000 per year and did not offer Larry any financial aid. Larry values attending Elite U at $60,000 per year. State College costs $30,000 per year, and offered Larry an annual $10,000 scholarship. Larry values attending State College at $40,000 per year. NoName U costs $20,000 per year, and offered Larry a full $20,000 annual scholarship. Larry values attending NoName at $15,000 per year. The opportunity cost of attending State College is

(1B): $15,000

(1B): You paid $35 for a ticket (which is non-refundable) to see JAM, a local rock band, in concert on Saturday. (Assume that you would not have been willing to pay any more than $35 for this concert.) Your boss called and she is looking for someone to cover a shift on Saturday at the same time as your concert. You will have to work 4 hours and she will pay you time and a half, which is $9/hr. What is the opportunity cost of going to the concert?

(1B): $36

(1B): Amy is thinking about going to the movies tonight. A ticket costs $7 and she will have to cancel her dog-sitting job that pays $30. The total cost (money cost plus opportunity cost) of seeing the movie is

(1B): $37

(1B): The marginal cost of upgrading from a 700 to an 800 Mhz computer is (PICTURE NEEDED)

(1B): $400

(1B): The marginal benefit of upgrading from a 600 Mhz computer to a 700 Mhz computer is (PICTURE NEEDED)

(1B): $500.

(1B): You had to pay $600 (non-refundable) for your meal plan for Fall semester which gives you up to 150 meals. If you eat only 100 meals, your average cost for a meal is

(1B): $6

(1B): Application of the cost-benefit principle would lead one to purchase a _______ computer because _______ . (PICTURE NEEDED)

(1B): 800 Mhz; the marginal benefits and marginal costs are equal

(1B): Sam and Adam are friends. Sam earns minimum wage at McDonalds and Adam earns $30 per hour as a machinist at a local factory. They both have Sundays off. They hang out together on Sundays and sometimes they watch a movie. A movie ticket costs $12 at the theater. Which of the following statements about the cost of the movie is correct?

(1B): Adam has a higher cost of watching the movie because his opportunity cost of time is greater.

(1B): Once a month Mr. Smith purchases a case (24 cans) of cola and puts it in his refrigerator for his 4 kids to share. Mr. Jones does the same for his 4 children, except that he opens up the case and gives each child 6 cans of cola for personal consumption. The children use cost-benefit analysis to decide on whether to open a can and drink its contents. Would you expect the cola to last equally long in both households? Why?

(1B): At both houses, the cost of drinking a cola now is that it's not available to drink later. In the Smith household this cost for an individual child is low because of the possibility that a sibling may drink it before he or she can. This gives each Smith child a strong incentive to consume the colas now rather than later. By contrast, the Jones household eliminates this incentive by not allowing any child to drink more than 6 colas. As a result, the Jones children can consume their colas at a slower, more enjoyable pace.

(1B): You and your friend Joe have identical tastes. At 2 p.m. you buy a non-refundable ticket to a basketball game through Ticketmaster. The price of the game ticket is $25 and the Ticketmaster surcharge is $5. The game will be played that night in Syracuse, which is a 50 mile drive from your home in Ithaca. Joe also wants to attend the game but decides to buy the ticket at the gate because he works during the day and cannot take time off to buy the tickets through Ticketmaster. Because there will be no Ticketmaster surcharge, his ticket cost will be $25. Although tickets through Ticketmaster are costlier, many people willingly pay the higher price because it offers them better seats because they booked their seats early. At 4 p.m. an unexpected snowstorm begins, making the prospect of driving to Syracuse much less attractive. At the same time, the snowstorm implies lower attendance at the game, making the chance of getting good seats higher. If both you and Joe are rational, is one of you more likely to attend the game than the other?

(1B): At the moment of deciding, therefore, the remaining costs Joe must incur to see the game are $25 higher than the remaining costs for you. And since you have identical tastes—that is, your respective benefits of attending the game are exactly the same, Joe will be less likely to make the trip.

(1B): Economics is best defined as the study of

(1B): How people make choices under the conditions of scarcity and the results of the choices.

(1B): Suppose a person makes a choice that seems inconsistent with the cost-benefit principle. Which of the following statements represents the most reasonable conclusion to draw?

(1B): The person (explicitly or implicitly) over-estimated the benefits or under-estimated the costs or both.

(1B): You want to watch a play, the ticket for which costs $100. You have just arrived at the theater to buy your ticket and discover that you have lost a $100 bill from your wallet. Do you buy a ticket and see the play anyway?

(1B): If you arrived at the ticket counter with the intention of watching the play after knowing the fact that the ticket will cost $100, it means that your marginal benefit from watching the play is at least $100. The marginal benefit represents the highest sum of money you are willing to give up to see the play. Having lost $100, you will be poorer and so you may now wish to spend less than $100 for the play. If so, you will go home. If not, you will buy another ticket and see the play.

(1B): You want to watch a play, the ticket for which costs $100. Now consider a different scenario. Suppose you have just arrived at the theater and discover that you have lost the $100 ticket you purchased earlier that day. Do you buy another ticket and see the play anyway?

(1B): If you lost the ticket that you had purchased for $100, you are still poorer by $100. So the answer is the same as above.

(1B): You want to watch a play, the ticket for which costs $100. Consider the two scenarios described above. Will you behave the same way or differently based on the two different scenarios above?

(1B): In both cases, you are $100 poorer than before. In both cases, the benefit of seeing the play, as measured by the maximum amount you are willing to pay, may therefore be slightly smaller, but this benefit is the same. In both cases, the additional cost you must incur to see the play is exactly $100. Since the relevant costs and benefits are the same in both cases, your decision should also be the same. If your ES (Economic Surplus) from the activity is greater than zero, you will see the play; if it is negative you will go home; and if zero you will be indifferent between seeing the play and going home.

(1B): Jenna decides to see a movie that costs $7 for the ticket and has an opportunity cost of $20. After the movie, she says to one of her friends that the movie was not worth it. Apparently,

(1B): Jenna overestimated the benefits of the movie.

(1B): You and your friend Joe have identical tastes. At 2 p.m. you buy a non-refundable ticket to a basketball game through Ticketmaster. The price of the game ticket is $25 and the Ticketmaster surcharge is $5. The game will be played that night in Syracuse, which is a 50 mile drive from your home in Ithaca. Joe also wants to attend the game but decides to buy the ticket at the gate because he works during the day and cannot take time off to buy the tickets through Ticketmaster. Because there will be no Ticketmaster surcharge, his ticket cost will be $25. Although tickets through Ticketmaster are costlier, many people willingly pay the higher price because it offers them better seats because they booked their seats early. At 4 p.m. an unexpected snowstorm begins, making the prospect of driving to Syracuse much less attractive. At the same time, the snowstorm implies lower attendance at the game, making the chance of getting good seats higher. If both you and Joe are rational, will Joe go to the game?

(1B): Joe, too, must weigh the opportunity cost of his time and the hassle of the drive in deciding whether to attend the game. But to that he must add the $25 he will have to spend for his ticket at the gate. He does not spend that money if he does not watch the game. Hence it is a marginal cost of attending the game. So Joe will attend the game if his marginal benefits exceed his marginal costs.

(1B): Mike, a whitewater rafting instructor, pays a non-refundable $100 to ACE Adventure to reserve a raft for a group whitewater rafting trip in the New River. The raft has room for 5 people. Mike usually sells 4 rafting tickets at $25 each and goes on the trip for free. But this time, he could only sell 3 tickets at $25 each for a total of $75. These amounts will have to be refunded by Mike if he cancels the trip. Should Mike cancel this trip?

(1B): No, because losing $25 is better than losing $100

(1B): You paid $35 for a ticket (which is non-refundable) to see JAM, a local rock band, in concert on Saturday. (Assume that you would not have been willing to pay any more than $35 for this concert.) Your boss called and she is looking for someone to cover a shift on Saturday at the same time as your concert. You will have to work 4 hours and she will pay you time and a half, which is $9/hr. Should you go to the concert instead of working Saturday?

(1B): No, your benefit is less than your cost

(1B): You and your friend Joe have identical tastes. At 2 p.m. you buy a non-refundable ticket to a basketball game through Ticketmaster. The price of the game ticket is $25 and the Ticketmaster surcharge is $5. The game will be played that night in Syracuse, which is a 50 mile drive from your home in Ithaca. Joe also wants to attend the game but decides to buy the ticket at the gate because he works during the day and cannot take time off to buy the tickets through Ticketmaster. Because there will be no Ticketmaster surcharge, his ticket cost will be $25. Although tickets through Ticketmaster are costlier, many people willingly pay the higher price because it offers them better seats because they booked their seats early. At 4 p.m. an unexpected snowstorm begins, making the prospect of driving to Syracuse much less attractive. At the same time, the snowstorm implies lower attendance at the game, making the chance of getting good seats higher. If both you and Joe are rational, will you go to the game?

(1B): Since you have already bought your ticket, the $30 you spent is a sunk cost. You cannot recover that money, irrespective of whether you go to the game or not. Therefore, to decide whether to attend the game, you should compare the benefit of seeing the game (as measured by the largest dollar amount you would be willing to pay to see it) to the additional costs you will incur to see the game (the opportunity cost of your time, and whatever cost you assign to driving through the snowstorm, etc., but NOT the $30 you paid for the ticket). You will go to the game if your marginal benefit exceeds your marginal cost.

(1B): Larry was accepted at three different graduate schools, and must choose one. Elite U costs $50,000 per year and did not offer Larry any financial aid. Larry values attending Elite U at $60,000 per year. State College costs $30,000 per year, and offered Larry an annual $10,000 scholarship. Larry values attending State College at $40,000 per year. NoName U costs $20,000 per year, and offered Larry a full $20,000 annual scholarship. Larry values attending NoName at $15,000 per year. Larry maximizes his surplus by attending

(1B): State College, because the difference between the benefit and cost is greatest there.

(1B): Alex received a four-year scholarship to State U that covered tuition and fees, room and board, and books and supplies. As a result

(1B): The cost of attending State U is the amount of money Alex could have earned working for four years.

(1B): Your scholarship depends on your maintaining a 3.5 cumulative GPA. Your GPA for last semester was 3.6, which brought your cumulative GPA down. What must be true?

(1B): Your marginal grades were lower than your overall GPA.

(1B): The incentive principle is an example of

(1B): a positive economic principle.

(1B): Chris has a one-hour break between classes every Wednesday. Chris can either stay at the library and study or go to the gym and work out. This is

(1B): an economic problem, because the one-hour time limit means Chris must make a choice.

(1B): Most people make some decisions based on intuition rather than calculation. This is

(1B): consistent with the economic model because people intuitively compare the relative costs and benefits of the choices they face.

(1B): The cost-benefit principle indicates that an action should be taken

(1B): if the extra benefit is greater than or equal to the extra cost.

(1B): Jody has purchased a non-refundable $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 cost-benefit analysis to choose between going to the concert and going on the date, she should

(1B): include only the entertainment value of the concert in the opportunity cost of going on the date.

(1B): In general, rational decision making requires one to choose the actions that yield the

(1B): largest economic surplus.

(1B): Normative economics is concerned with how people _________ make decisions while positive economics is concerned with how people __________ make decisions.

(1B): should; do

(1B): The incentive principle states that a person is more likely to do something if

(1B): the benefits from doing it increase.

(1B): Dean should play golf instead of preparing for tomorrow's exam in Economics if:

(1B): the economic surplus from playing golf is greater than the economic surplus from studying.

(1B): Choosing the 700 Mhz computer would be inefficient because

(1B): the marginal benefit is greater than the marginal cost.

(1B): Choosing the 1,000 Mhz computer would be inefficient because (PICTURE 2 NEEDED)

(1B): the marginal cost is more than the marginal benefit, the total net benefit will rise if you choose a slower computer.

(1B): Economists use abstract models because

(1B): they are useful for describing general patterns of behavior.

(1B): The use of economic models, such as the cost-benefit principle, means that economists believe that

(1B): this is a reasonable abstraction of how people choose between alternatives most of the time.

(1B): The scarcity principle indicates that

(1B): with limited resources, having more of something means having less of something else.