Homework 2.1 How Individuals Make Choices Based on Their Budget Constraint

Sunk costs should have ______________.

no effect on output decisions Sunk costs are actually costs that should be ignored when making a decision. A rational economic actor making a decision should be forward-looking and consider prospective costs and not consider costs that have been incurred and cannot be recovered.

Assume Brandon can buy either 1 DVD for $20 or 3 CDs for $25. What is the opportunity cost if he decides to buy 3 CDs?

the lost opportunity to buy 1 DVD. Opportunity cost is the cost of what must be given up to obtain something that is desired. Since Brandon spends all of his money on CDs, he is giving up the opportunity to purchase a DVD.

Which of the following is an example of a sunk cost? Perfect. Your hard work is paying off 😀 Chris purchases a ticket for a movie but leaves halfway through because it is too scary. Jenny purchases a new winter coat online but returns it because it is too small. Kyle's laptop crashes, but it is still under warranty, so he is able to have it repaired at no cost. Amy buys lunch at a restaurant and dislikes the food. The manager of the restaurant agrees to give her a refund for the meal.

Chris purchases a ticket for a movie but leaves halfway through because it is too scary. Sunk costs are costs that cannot be recovered. Of these examples, the only cost that the consumer cannot get back is the cost of the movie ticket. In this case, regardless of whether or not Chris enjoys the film, he is not able to get his money back since the ticket is purchased upfront.

Suppose your marginal cost of making a peanut butter and jelly sandwich is constant at $10, but the marginal benefit of eating the sandwich decreases from $12 for one sandwich, to $10 for two sandwiches, to $8 for three sandwiches, to $6 for four sandwiches. How many sandwiches would you eat?

2 sandwiches Recall that you continue an activity as long as marginal benefit is greater than or equal to marginal cost. Therefore, you would eat two sandwiches since any number of sandwiches beyond this would give MC>MB (the costs outweigh the benefits).

Suppose that a firm invests $5 million in the development of a new product that generates only about $250,000 in revenue after a full year on the market. The firm only has a patent for one year and other firms are likely to start producing similar products. Which of the following is the most rational decision for the firm to make?

Forget the new product, accept the loss of the investment and work on innovations that show signs of being more profitable. The lesson of sunk costs is to forget about the money and time that is irretrievably gone and instead to focus on the marginal costs and benefits of current and future options. This often means admitting an earlier error in judgment. Many firms, for example, find it hard to give up on a new product that is doing poorly because they spent so much money in creating and launching the product.

Anna has a fixed budget for entertainment for the year and likes movies and concerts. If Anna spends her entire budget on movies, she can go to 70 movies. If she spends her entire budget on concerts, she can go to 35 concerts. What is the opportunity cost of a concert?

If Anna is spending her entire entertainment budget and goes to a concert, then she must give up 70/35=2 movies.

Which scenario is asking you to apply marginal analysis? Correct! You nailed it. Smaller economies like Belgium, Korea, and Pakistan are better equipped to take full advantage of division of labor, specialization, and economies of scale within their own borders. Do you agree? It costs $3 to go down the water slide. The first time you go down the slide, you are really excited, but your interest decreases each time you go down. How many times should you go down the water slide? You have a budget of $5 and the price of bananas is 0.50 per pound. How many pounds of bananas can you afford? Willingness to pay for a good is downward-sloping. What is this curve called?

It costs $3 to go down the water slide. The first time you go down the slide, you are really excited, but your interest decreases each time you go down. How many times should you go down the water slide? Marginal analysis involves comparing marginal benefits and marginal costs to determine the optimal outcome.

In marginal analysis, when comparing costs and benefits, an optimal choice is found when ______. (Note: MB = marginal benefit, MC = marginal cost, TB = total benefit, and TC = total cost.)

MB≥MC If possible, we want to choose an outcome or output where MB=MC. If an exact equality is not possible (because of, say, indivisible units of output), then we want to be as close to equality as possible, with MB slightly more than MC. In general, one should always choose to consume if the marginal benefit of doing so is greater than the marginal cost (MB>MC). This implies that the optimal level of consumption occurs where marginal benefit is equal to marginal cost (MB=MC).

If a family spends its entire budget in a given time frame, the family can afford either 90 cans of soup or 60 frozen dinners. Assuming the family spends its entire budget on just these two goods, what is the opportunity cost of one extra can of soup in the time frame?

Opportunity cost can be calculated as the ratio of amounts of each good that could be consumed if the entire budget were spent only on that good. Therefore, the opportunity cost of an extra can of soup is 60 frozen dinners90 cans of soup≈0.67 frozen dinners. Rounded to 0.7

True or false?The marginal satisfaction associated with consumption of a product can also be described as the marginal utility.

True Utility is used to measure the satisfaction that individuals receive from consuming goods and services. The additional benefit of consuming another unit of a good is the marginal utility.