chapter 1 problems and applications Flashcards
enter it
enter it
you are trying to decide whether to take a vacation. most of the costs of the vacation (airfare, hotel, forgone wages) are measured in dollars, but the benefits of the vacation are psychological. how can you compare the benefits to the costs?
when the benefits are psychological, it isn’t easy to compare benefits to costs to determine if it is worth doing
- but there are two ways to think about it
1. compare the vacation with what you would do in its place (ie buy new golf clubs) - then you can decide if you’d rather have the new clubs or the vacation
- how much work you had to do to earn the money to pay for the vacation; then you can decide if the psychological benefits of the vacation were worth the psychological cost of working
you were planning to spend Saturday working at your part-time job, but a friend asks you to go skiing. what is the true cost of going skiing?
now suppose that you had been planning to spend the day studying at the library. what is the cost of going skiing in this case?
- the cost of skiing includes the monetary and time costs, which includes the opportunity cost of the wages you are giving up by not working
- the cost of skiing is its monetary and time costs including the cost to you of getting a lower grade in your course.
you win $100 in a hockey pool. you have a choice between spending it now or putting it away for a year in a bank account that pays 5% interest. what is the opportunity cost of spending the $100 now.
if you spend $100 now instead of saving it for a year and earning 5%, you are giving up the opportunity to spend $105
- remember the time value of money
The company that you manage has invested $5 million in developing a new product, but the development is not quite finished. at a recent meeting, your sales people report that the introduction of competing products has reduced the expected sales of your new product to $3 million. if it would cost $1 million to finish development and make the product, should you go ahead and do so? what is the most that you should pay to complete development
$5 million spent is a sunk cost (not in the equation)
since the money is gone
- what matters now is the chance to earn profits at the margin
- if you spend another $1 million and can generate sales of $3 million, you’ll earn $2 million in marginal profit, so you should do so
- you are right to think that the project has lost a total of $3 million ($6 mill in costs and only 3 mill in revenue) and you shouldn’t have started it
- but if you don’t spend the additional $1 million, you won’t have any sales and your losses will be $5. so what matters is not the total profit ,but what you can earn at the margin
- you can pay up to $3 million to complete development ; anymore than that and you won’t be increasing profit at the margin
The welfare system provides income for people who are very poor, with low incomes and few assets. if a recipient of welfare payments decides to work and earn some money, the amount he or she receives in welfare payments is reduced
a. how does this existence o the welfare system affect people’s incentive to save money for the future?
b. how does the reduction in welfare payments associated with higher earnings affect welfare recipients’ incentive to work?
a. the provision of welfare benefits lowers an individual’s incentive to save fro retirement. the benefits provide some level of income to the indivdiual when he or she reitres. this means that the individual is not entirely dependnet on saving to support consumption throught the years in retirement
b. since a person gets fewer after-tax welfare benefits thte greater is his or her eranings, there is an incentive not to work (or not work as much) after age 65. the more you work, the lower your after-tax welfare benefits will be. Thus taxation of welfare benefits discourages work effort after age 65.
In 1997, the gov. of Ontario reformed that province’s welfare system. the reform reduced the amount of welfare payments to a person with no income, but also allowed welfare recipients to keep a larger part of their welfare payments if they did earn some income.
a. how does this reform affect the incentive to work?
b. how might this reform represents a tradeoff between equity and efficiency?
a. the loss benefits means that rt someone who can’t find a job will get no income at all, so the distribution of income will become less equal. but the economy will be more efficient, since welfare recipients ahve a greater incentive to find jobs
b. the change in the law is one that increases efficiency but reduces equity
your roommate is a better cook than you are, but you can clean more quickly than your roommate. if your roommate did all of the cooking and you did all of the cleaning, would your chores take you more ore less time than if you divided each task evenly? give a similar example of how specialization and trade can make two countries better off.
by specializing in each task you and your roommate can finish the chores more quickly.
countries can specialize and trade, making bot better off. for example suppose it takes spanish workers less time to make clothes than french workers, and french workers can make wine more efficiently than Spanish workers. then Spain and France can both benefit if for the exchange
nations with corrupt police and court systems typically have lower standards of living than nations with less corruption. why might that be the case?
these activities tend to lessen the efficiency of an economic system, hence reducing the economic productivity of a nation. lower productivity means lower standards of living
Explain whether each of the following government activities is motivated by a concern about equity or a concern about efficiency. in the case of efficiency, discuss the type of market failure involved.
a. regulating cable tv prices
b. providing some poor people with free prescription drugs
c. prohibiting smoking in public places
d. preventing mergers between major banks
e. imposing higher personal income tax rates on people with higher incomes
f. instituting laws against driving while intoxicated
a. efficiency: the market failure comes form the monopoly by the cable tv firm
b. equity
c. efficiency: an externality arises because secondhand smoke harms nonsmokers
d. efficiency: the market failure form the monopoly occurring form the merger
e. equity
f. efficiency: there is an extenrality because of accidents caused by drunk drivers
Discuss each of the following statements from the standpoint of equity and efficiency
a. everyone in society should be guaranteed the best healthcare possible
Finish
In what ways is your standard of living different from that of your parents or grandparents when they were your age? Why have these changes occurred?
Since average income in Canda has roughly doubled every 35 years, we are likely to have a better standard of living than our parents, in a much better standard of living than our grandparents. This is mainly the result of increased productivity, so that an hour of work produces more goods and services than it used to. Thus incomes have continuously risen over time, as has a standard of living.
Supposed Canadians decide to save more their incomes. Is banks lens this extra savings to businesses, which use the funds to build new factories, how might this lead to faster growth and productivity? Do you suppose benefits from higher productivity?’s is society getting a free lunch?
If Canadian save more and it leads to more spending on factories, there will be an increase in production and productivity, since the same number of workers will have more equipment to work with.
The benefits from higher productivity will go to both the workers, who will get paid more since they’re producing more, in the factory owners, who will get a return on their investment. There is no such thing as a free lunch, however, because when people save more, they are giving up spending. They get higher incomes at the cost of buying few were goods.
Imagine that you are policymaker trying to decide whether to reduce the rate of inflation. To make an intellectual decision, what would you need to know about inflation, unemployment, and the trade-off between them?
You need to know what causes inflation and unemployment, as well as what determines a trade off between them.
Any attempt to reduce inflation will likely lead to higher unemployment in the short run.
A policymaker the space is a trade-off between the benefit of Lawrence Laois and compared to the cost of higher unemployment.
A policymakers deciding how to finance the construction of the new airport. He can either pay for it by increasing citizens taxes or by printing more money. What are some of the short run and long-run consequences of each option?
Increasing taxes to finance a planned increase in government spending leaves less money for people to spend, the’s reducing their demand for goods and services, which may increase unemployment in the short run.
In the long run, this solution avoids a search in relation. Printing money, on the other hand reduce his unemployment in the short run while increasing inflation.
Which solution is better depends whether the economy is in a period of rapid growth (when taxes are the better option) or in recession (when printing money may be a better choice)
