ECON:1100 Chapter 1 Questions

Why is it so difficult to ignore costs we have actually already paid?

Because they are explicit and we actually handed over a check. - Because we actually handed money to someone or wrote a check to someone.

Some friends and I are heading to a concert. We all have purchased $50 tickets. I just realized that I lost my ticket on the subway ride to the concert. I am confronted now with a decision of whether or not to buy a new ticket and go to the concert . Which of the following best describes that decision?

Is the concert worth paying $50 to attend? - The lost ticket is a sunk cost. I cannot get it back. Thus, the cost of going is buying a $50 ticket (plus the value of the time I will spend).

Is the income you could earn after going to college part of the cost of going to college?

No - That is one of the benefits. Not a cost.

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?

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.

Your college purchased a building east of campus for $500,000. Given changes in the city's real estate market, the current market value of the building is now $2 million. The total value of the use of the building for the college is estimated to be $1.5 million. What should your college do? Explain why.

Not use the building. Using the building would mean losing $ .5 million in doing so.

If a good or service is scarce, which of the following is true? I. There is a shortage at the going market price. II. Buyers cannot afford to purchase the product III. We must give something up if we want more of the good. IV. It is difficult to find the product in stores. V. Production is very rare.

We must give something up if we want more of the good. - A shortage only means that at the current price the quantity demanded is greater than the quantity supplied. The core of scarcity is not a shortage, but that we have to give up something else (time, alternative goods and services, etc.) if we want to enjoy any of this good or service.

Is tuition a part of the cost of deciding to go to college?

Yes - It is part of the cost because we have to give that amount of money to the college if we go. And we don't have to give that amount up, if we decide not to go.

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?

$1,100,000 - The value of the best alternative is $1,100,000.

I started a business last year. My revenues were $100,000. My rent and materials costs were $60,000. My best alternative was and is to go to work for a company in a job that would pay me $30,000. The "true" (economic) profits from my business were _____. (hint: when calculating economic profit we would take into account all types of costs).

$10,000 - My revenues are $100,000. My costs of generating those revenues are the payments for rent and materials ($60,000) and the $30,000 that I could earn in my best alternative job. Thus my "true" profit is the $100,000 minus $90,000.

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 _____.

$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.

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 _______.

$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.

The opportunity cost of spending a night with friends is which of the following? I. The movie I could have seen II.The several hours of sleep I could have had III.The better grade I could have earned with more study

A, B, or C, but not all of them - The opportunity cost is the most desirable of these. I would not have given up all three.

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?

Always do it - We should always make the decision to do it. If the benefits of doing something else are greater, then that is part of the cost and that makes the cost greater than the benefits.

Why is it so difficult to consider costs that we have not physically paid as part of the cost of the decision?

Because we have not directly paid someone. - These costs are implied. We gave a sum up instead of accepting payment. So, it is a real cost. We would have had that amount.

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?

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).

If I have to drop out of college, it will cost me all of the tuition I have paid and the income I could have earned during those years while I was in college. True or false.

False. I did pay these costs, but they are sunk and thus not relevant to the decision.

Which of the following does not represent an opportunity cost of attending college? I. Tuition Paid II. Income that one could have earned instead of going to college III. Food IV. Books purchased at college

Food purchased at college will not be part of the cost. One must purchase food whether one goes to college or not. (The increase in costs of food is part of the opportunity cost if one is spending more than one would at home.)

Is room and board part of the cost of the decision to go to college?

Part of room and board may be part of the cost. - If room and board is more expensive than what your family spends on you at home, then that increase is a part of the cost. If your family continues to spend the same amount on housing and eating once you are gone (unlikely in the case of food), then the entire cost of room and board is part of the cost of going to college.

In every economy, resources are limited, but wants are large and increasing. What is this problem called?

Scarcity - the condition that our wants are greater than our abilities to satisfy them, forces us to make choices among competing uses of resources.

Last year, you purchased land to build a retail store. You paid $20 million for the land. Another business has now offered $8 million for the land and that is the highest price your business should now be able to get for the land. Which of the following costs is relevant for your decision as to whether or not you should build a new retail store?

The $20 million is a sunk cost. The $8 million is the best offer and that is the opportunity cost. That is what one would give up if you built a new retail store now.

Tickets to a sold-out basketball game originally cost $50 each and cannot be returned. I bought one and now scalpers are willing to pay $125 for the ticket. The cost that should be considered if I am deciding whether or not to go to the game is _____.

The $50 is sunk. The $125 is the actual amount I will give up if I choose to go to the game.

I am thinking about going out to visit with some friends tonight. Given what I have learned in economics, I am comparing my costs with my expected benefits. My alternatives in order of preference are to stay in my room and watch TV; stay in my room and study economics; have my friends over to my room; or go to bed early tonight. What are the costs relevant to my decision?

The benefits gained from staying in my room and watching TV - I am giving up the best alternative, not all of the alternatives. And staying in my room and watching TV is the most valuable alternative.

A small clothing firm currently produces 50,000 shirts and blouses per month. The costs of its factory, raw materials, and labor is $500,000 per month. If the company is to increase production by 5,000 and that requires an additional labor and raw material expense of $100,000, what is the best estimate of costs of the increased production?

The best estimate of costs is what one has to give up to increase production. In this case it is $100,000.

What is the cost per shirt before the increase in production? Part of the information is repeated for you below. A small clothing firm currently produces 50,000 shirts and blouses per month. The costs of its factory, raw materials, and labor is $500,000 per month. If it is to increase production by 5,000, that requires an additional labor and raw material expense of $100,000.

The cost is $500,000 divided by 50,000. That is, it is equal to $10.00.

A business has spent $50 million dollars on development of a new laptop. It must spend an additional $20 million to bring the finished computer to market. What must the value of the investment be for it to make sense for the business?

The value, if any, of the results of the $50 million spent so far, plus the $20 million. - The remaining required expenditure of $20 million is the easiest part to see. But if I could use the results of the development to date in an alternative project, or sell those results to another company, then the value in the alternative project or the amount I could get from selling those results to someone else, should also be included. If I cannot sell the results of that development or use them in an alternative project, then they should not be included as part of the consideration of whether or not to continue.

Good economic decision-making means which of the following? I. Comparing all of the benefits with all of the costs related to the production and enjoyment of a good II. Thinking about marginal benefits and marginal costs of the good and services III. Thinking about average benefits and average costs of the goods and services

Thinking about marginal benefits and marginal costs of the good and services - Rational choices require us to compare how our benefits and our costs will change as a result of a decision. So, we should think 'on the margin'. What additional benefits will we generate? What additional costs will we have to pay?

Is the money, you could have earned instead of going to college, part of the cost of going to college?

Yes - Yes, it is because if that is what you would be doing instead of college, you are giving it up.

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?

Yes, it was rational. - The cost of the old set was literally sunk, but also in an economic sense so it 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.

Suppose you bought a basketball game ticket with $30 and no refunds are possible. What is your opportunity cost of attending the basketball game ?

Zero, plus what I would have done with my time. - The correct answer is that even though I paid $30 for the ticket, it has no value now beyond getting me into the concert. Thus, the cost of going to the concert at this point is zero, plus what I would have done with my time. I cannot get my money back; I cannot sell it to someone else. (Let's just assume that I am not allowed to give it to someone. If I could, there might be some benefit in doing so.) The idea is that the amount you originally paid is now irrelevant. What is relevant is what you are giving up at this time by going to the concert. The original payment is irrelevant. Whether you go to the concert or not will not affect that fact that you already paid the $30. The amount that you have already spent is a sunk cost. That amount is not affected by the choice you make now. It is sunk in that it is no longer available; it is gone; it is irrelevant to the current decision.