Econ 1900 Study Guide 2

In her previous job, Mei was earning $38,000 a year. She now has a new job where she is paid an annual salary of $42,000. What was Mei's economic profit when she switched jobs? A. $42,000 B. $38,000 C. $4,000 D. $0

$4,000

How you go about finding the optimal quantity when the choice involves a small number of quantities.?

(In this example, one through five years.) With small quantities, the rule for choosing the optimal quantity is: increase the quantity as long as the marginal benefit from one more unit is greater than the marginal cost, but stop before the marginal benefit becomes less than the marginal cost.

What is a sunk cost?

A sunk cost is a cost that has already been incurred and is nonrecoverable. A sunk cost should be ignored in decisions about future actions.

What is either or decision making?

According to the principle of "either-or" decision making, when faced with an "either-or" choice between two activities, choose the one with the positive economic profit.

What is an implicit cost?

An implicit cost does not require an outlay of money; it is measured by the value, in dollar terms, of benefits that are forgone.

Karma and Don run a furniture-refinishing business from their home. Does the following- A van that they inherited and use only for transporting furniture-represent an explicit cost of the business and which represent an implicit cost?

By using the van for their business, Karma and Don forgo the money they could have gained by selling it. So use of the van is an implicit cost.

What is capital?

Capital is the total value of assets owned by an individual or firm—physical assets plus financial assets.

Think of an example of when there would be a decreasing marginal cost

Decreasing marginal cost is often due to learning effects in production: for complicated tasks, such as assembling a new model of a car, workers are often slow and mistake-prone when assembling the earliest units, making for higher marginal cost on those units. But as workers gain experience, assembly time and the rate of mistakes fall, generating lower marginal cost for later units. As a result, overall production has decreasing marginal cost.

What is economic profit?

Economic profit is equal to revenue minus the opportunity cost of resources used. It is usually less than the accounting profit.

What does the line on a cost curve look like if we get increasing marginal costs?

It looks like a swoosh curve (nike swoosh)

Which of the following is NOT considered an explicit cost of attending college? A. Tuition B. Room and board C. Lab and student fees D. Lost income from a job you had to quit

Lost income from a job you had to quit

Karma and Don run a furniture-refinishing business from their home. Does the following-Supplies such as paint stripper, varnish, polish, sandpaper, and so on- represent an explicit cost of the business and which represent an implicit cost?

Supplies are an explicit cost because they require an outlay of money.

You and your friend are at the stadium watching your favorite football team. But they are losing so badly that you can't bear to watch anymore and want to leave. Your friend, however, says, "But we paid $100 for these seats. Shouldn't we stay and get our money's worth?" How do you respond?

The cost of the ticket is a sunk cost and cannot be recovered. The decision to remain at the game should be based on the marginal benefits of continued attendance, and the marginal cost of continuing to watch your favorite team lose.

What is the optimal quantity?

The optimal quantity is the quantity that generates the highest possible total profit.

What is a decreasing marginal benefit?

There is decreasing marginal benefit from an activity when each additional unit of the activity yields less benefit than the previous unit.

What role does the concept of opportunity cost play in decision making?

This illustrates an important aspect of opportunity cost: in considering the cost of an activity, you should include the cost of using any of your own resources for that activity. You can calculate the cost of using your own resources by determining what they would have earned in their next best use.

Karma and Don run a furniture-refinishing business from their home. Does the following-Wages paid to a part-time helper- represent an explicit cost of the business and which represent an implicit cost?

Wages are an explicit cost.

What does the line on a marginal cost curve look like if there is constant marginal cost?

With constant marginal cost, the marginal cost curve is a horizontal line.

What does the line on a marginal cost curve look like if there is decreasing marginal cost?

With decreasing marginal cost, the marginal cost line is downward sloping.

What is the profit maximizing principle of marginal analysis?

According to the profit-maximizing principle of marginal analysis, when faced with a profit-maximizing "how much" decision, the optimal quantity is the largest quantity at which marginal benefit is greater than or equal to marginal cost.

What is accounting profit?

Accounting profit is equal to revenue minus explicit cost.

What is an explicit cost?

An explicit cost is a cost that requires an outlay of money.

Which of the following is true about accounting profit and economic profit? A. Accounting profit considers both explicit and implicit costs. B. Accounting profit considers only implicit costs. C. Economic profit considers only explicit costs. D. Economic profit considers both explicit and implicit costs.

Economic profit considers both explicit and implicit costs

Suppose that at your current level of consumption, marginal benefit of the most recent unit is 6, and marginal cost is 5. Which of the following is true? A. You must be maximizing economic profit. B. If possible, you should consume more units until marginal benefit equals marginal cost. C. If possible, you should consume more units until marginal benefits are less than marginal cost. D. You must reduce consumption until the difference between marginal benefit and marginal cost is greatest.

If possible, you should consume more units until marginal benefit equals marginal cost.

Karma and Don run a furniture-refinishing business from their home. Does the following- Basement space that has been converted into a workroom-represent an explicit cost of the business and which represent an implicit cost?

If the basement could be used in some other way that generates money, such as renting it to a student, then the implicit cost is that money forgone. Otherwise, the implicit cost is zero.

How do you go about finding the optimal quantity when the choice involves relatively large quantities?

In contrast, when a "how much" decision involves relatively large quantities, the rule for choosing the optimal quantity simplifies to this: The optimal quantity is the quantity at which marginal benefit is equal to marginal cost.

What is a common mistake when a person is making an either or economic decisions?

In making "either-or" decisions, mistakes most commonly arise when people or businesses use their own assets in projects rather than rent or borrow assets. That's because they fail to account for the implicit cost of using self-owned capital. In contrast, when they rent or borrow assets, these rental or borrowing costs show up as explicit costs

Karma and Don run a furniture-refinishing business from their home. Does the following- The job at a larger furniture restorer that Karma gave up in order to run the business-represent an explicit cost of the business and which represent an implicit cost?

Karma's forgone wages from her job are an implicit cost.

What is marginal analysis?

Marginal analysis involves comparing the benefit of doing a little bit more of some activity with the cost of doing a little bit more of that activity.

What is the role of opportunity cost?

Opportunity costs arise because resources are scarce. Because resources are scarce, the true cost of anything is what you must give up to get it—its opportunity cost.

What does it mean when we say that the production of a good or service has a constant marginal cost?

Production of a good or service has constant marginal cost when each additional unit costs the same to produce as the previous one.

What does it mean when we say that the production of a good or service has a decreasing marginal cost?

Production of a good or service has decreasing marginal cost when each additional unit costs less to produce than the previous one.

What does it mean to say that the production of a good or service has an increasing marginal cost?

Production of a good or service has increasing marginal cost when each additional unit costs more to produce than the previous one.

Which of the following is an example of increasing marginal cost? A. On-the-job training makes it easier for workers to produce. B. Planting a second field with crops costs the same as planting the first field. C. The further Steven goes in his education, the more difficult the schoolwork becomes. D. Learning a new production technique allows workers to produce more than they ever could in the past.

The further Steven goes in his education, the more difficult the schoolwork becomes.

What is the implicit cost of capital

The implicit cost of capital is the opportunity cost of the use of one's own capital—the income earned if the capital had been employed in its next best alternative use.

What is a marginal benefit curve?

The marginal benefit curve shows how the benefit from producing one more unit depends on the quantity that has already been produced.

What is the marginal benefit of a good or service?

The marginal benefit of a good or service is the additional benefit derived from producing one more unit of that good or service.

What does the marginal cost curve show?

The marginal cost curve shows how the cost of producing one more unit depends on the quantity that has already been produced.

What is the marginal cost of producing a good or service?

The marginal cost of producing a good or service is the additional cost incurred by producing one more unit of that good or service.

You have gone through two years of medical school but are suddenly wondering whether you wouldn't be happier as a musician. Is the following statement a potentially valid arguments and or not? "I wasted two years, but never mind—let's start from here."

This is a valid argument because it recognizes that sunk costs are irrelevant to what you should do now.

You have gone through two years of medical school but are suddenly wondering whether you wouldn't be happier as a musician. Is the following statement a potentially valid arguments and or not? "My parents would kill me if I stopped now." (Hint: We're discussing your decision-making ability, not your parents'.)

This is a valid argument given that you are concerned about disappointing your parents. But your parents' views are irrational because they do not recognize that the time already spent is a sunk cost.

You have gone through two years of medical school but are suddenly wondering whether you wouldn't be happier as a musician. Is the following statement a potentially valid arguments and or not? "If I had thought about it from the beginning, I never would have gone to med school, so I should give it up now."

This is also an invalid argument because what you should have done two years ago is irrelevant to what you should do now.

You have gone through two years of medical school but are suddenly wondering whether you wouldn't be happier as a musician. Is the following statement a potentially valid arguments and or not? "I can't give up now, after all the time and money I've put in."

This is an invalid argument because the time and money already spent are a sunk cost at this point.

Ashley Hildreth faced the choice of either completing a two-year graduate program in teaching or working at a job in advertising. Assume that she has a third alternative to consider: entering a two-year apprenticeship program for skilled machinists that would, upon completion, make her a licensed machinist. During the apprenticeship, she earns a reduced salary of $15,000 per year. At the end of the apprenticeship, the value of her lifetime earnings is $725,000. What is Ashley's best career choice?

We need only compare the choice of becoming a machinist to the choice of taking a job in advertising in order to make the right choice. We can discard the choice of acquiring a teaching degree because we already know that taking a job in advertising is always superior to it. Now let's compare the remaining two alternatives: becoming a skilled machinist versus immediately taking a job in advertising. As an apprentice machinist, Ashley will earn only $30,000 over the first two years, versus $57,000 in advertising. So she has an implicit cost of $30,000 −$57,000 = − $27,000 by becoming a machinist instead of immediately working in advertising. However, two years from now the value of her lifetime earnings as a machinist is $725,000 versus $600,000 in advertising, giving her an accounting profit of $125,000 by choosing to be a machinist. Summing, her economic profit from choosing a career as a machinist over a career in advertising is $125,000 − $27,000 = $98,000. In contrast, her economic profit from choosing the alternative, a career in advertising over a career as a machinist, is −$125,000 + $27,000 = −$98,000. By the principle of "either − or" decision making, Ashley should choose to be a machinist because that career has a positive economic profit.

Suppose you have three alternatives—A, B, and C—and you can undertake only one of them. In comparing A versus B, you find that B has an economic profit and A yields an economic loss. But in comparing A versus C, you find that C has an economic profit and A yields an economic loss. How do you decide what to do?

You can discard alternative A because both B and C are superior to it. But you must now compare B versus C. You should then choose the alternative—B or C—that carries a positive economic profit.

You have decided to go into the ice-cream business and have bought a used ice-cream truck for $8,000. Now you are reconsidering. What is your sunk cost in the following scenario-The truck can be resold, but only at a 50% discount.

Your sunk cost is $4,000 because 50% of the $8,000 spent on the truck is recoverable.

You have decided to go into the ice-cream business and have bought a used ice-cream truck for $8,000. Now you are reconsidering. What is your sunk cost in the following scenario-The truck cannot be resold.-?

Your sunk cost is $8,000 because none of the $8,000 spent on the truck is recoverable.