Give three examples of important trade-offs that you face in your life.
- When I choose which kind of drinks to buy in a cafe, I give up black coffee for latte.
- When I choose how to spend my afternoon, I give up several hours of reading books for doing exercises in the fitness centre.
- When I choose which subject to study today, I give up math for economics.
What is the opportunity cost of seeing a movie?
The amount of money to pay for the ticket price, the things that could be done during the time and other movies that could be watched.
Water is necessary for life. Is the marginal benefit of a glass of water large or small?
I think that depends on how much water one already have. For an extremely thirsty man it is large while for a man who does not lack water it is small.
Why should policymakers think about incentives?
If a policy changes incentives, it will cause people to alter their behavior because they respond to incenttives. Policy can change people's behavior and have some indirect effects which are sometimes not obvious.
Why isn't trade among countries like a game with some winners and some losers?
Trade allows a group of people focus on what they are best at and then let them produce as much as possible to benefit all who are involved in a trade. Each country is gifted with particular conditions for example while some countries have the advantage of soil allowing them to produce more food others have more mineral resources. I think trade is a fair way for countries to help each other.
What does the "invisible hand" of the marketplace do?
It leads people to make self-serving decisions after looking at the prices to reach an outcome that maximize the welfare of society as whole.
Explain the two main causes of market failure and give an example of each.
- Externality - A trade may create costs or benefits for third parties. When externalities are not considered in a trade because neither sellers or buyers can be harmed or benefit from them, it is not the overall cost and benefit that is driving the trade but just part of them. Thus, the market is not going after the maximized welfare. As an example of positive externality, when a company builds a park for the government, the money it receives is lower than the value of the park and it caused less company being willing to build parks. A negative externality is that, the money that a company spends on building a chemical factory can be lower than the actual cost of it if you count in the environment cost and it results in more company willing to build them.
- Market Power - It refers to the power to change prices of a group of buyers or sellers. When there is no competitor in the market, a seller or buyer will be relied on by the opposite side. Then the price will not be determined by both sides. For example, in China eletirc power supply is controlled by government resulting in that only government can decide the price of electricity.
Why is productivity important?
Because productivity is the primary determinant of living standards.
What is inflation and what causes it?
Inflation is an increase in the overall level of prices in the economy. It is the growth in the quantity of money that causes inflation.
How are inflation and unemployment realted in the short run?
Growth in the quantity of money causes inflation and growth of spending ability. Thus demand increases and unemployment decreases. In a word, in the short run you can defeat unemployment by inflation.
PROBLEMS AND APPLICATIONS
1. Describe some of the trade-offs faced by each of the following individuals:
a. Janice, who is deciding which courses to take next semester.
When Janice choose to take subject set A which include a, b and c, she gives up the subjects that don't belong to set A.
b. The CEO of a hospital, who is trying to decide whether to build a neonatal intensive care facility.
The CEO has two choice: spend the resources on building this facility or spend the resources on something else. Apparently if he/she choose the former he/she has to give up the latter and vice versa.
c. Harold and Kumar, who are trying to decide what to do this weekend.
The things that Harold and Kumar will do this weekend make up set A. By making this decision, they have to give anything that doesn't belong to set A.
d. A city councilman, who is trying to decide how much to spend on a downtown parking garage.
By adding a sum of money to the spending of garage he give up using the money to do other things. So this is a trade-off between the garage or other things where a sum of money is going to be spent.
2. You are trying to decide whether to take a vacation. Most of the costs of the vacation (airfare, hotel and forgone wages) are measured in dollars, but the benefits of the vacation are psychological. How can you compare the benefits to the costs?
It is a trade-off between psychological enjoyment and pecuniary cost. First I should focus on the marginal cost and benefit. Second I can converse the psychological enjoyment into pecuniary benefit by thinking about how much should I pay to gain such enjoyment if I don't take the vacation and compare it with the cost.
3. You have an economics exam tomorrow and you are planning to study tonight. Your best friend calls to tell you that he has an extra ticket to a concert tonight that he will give to you (for free). What is the true cost of attending the concert? Now, suppose that you are scheduled to work tonight at your part-time job. What is the true cost of attending the concert in this case? Explain.
Principle 2: The cost of something is what you give up for it.
- In the first case, the cost of attending the concert is what I give up for it, in other words, the time that was planned to be spent on studying. Furthermore, I give up the d-value between the score I would get if I used the concert time to study and the score I actually get after I attend the concert.
- In the second case, the cost of attending the concert is what I give up for it, in other words, the work I should do if I used to concert time to work. Calculating in dollars, that is the value of the work I should have done with the concert time.
4. You win $100 in a basketball pool. You have a choice between spending the money now or putting it away for a year in a bank account that pays 5 percent interest. What is the opportunity cost of spending the $100 now?
The opportunity cost is the benefit of another choice which, in this case, is putting it in a bank account to gain 5 percent interest after a year. So the benefit of putting it in a bank account is $5 a year later and it is the opportunity cost of spending the $100 now.
5. 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 salespeople 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?
Now I have two choices.
If I stick to the old plan, then I will lose $2 million.
If I finish development and make the product with the extra $1 million, when I will lose $3 million.
The opportunity cost of the former is the benefit of the latter which is the time it saves. Suppose during the time saved by the latter plan, the company can make a profit A.
Considering the latter plan as an adjustment to the former then there is a marginal cost and benefit. The marginal cost is the extra $1 million and the marginal benefit is profit A. By comparing A and $1 million I can make the decision.
If A is less than $1 million then the marginal benefit is smaller than the marginal, I will choose to stick to the old plan. If A is more than $1 million, I will do the adjustment.
6. Three managers of the Magic Potion Company are discussing a possible increase in production. Each suggests a way to make this decision.
- HARRY: We should examine whether one company's productivity - gallons of potion per worker - would rise or fall.
- RON: We should examine whether our average cost - cost per worker - would rise or fall.
- HERMIONE: We should examine whether the extra revenue from selling the additional potion would be greater or smaller than the extra costs.
The key to this question is to decide which index can best represent production.
Production = productivity × number of workers
Productivity is able to show production if and only if the number of workers is fixed.
Production = number of workers × average cost × production out of per unit of cost
Average cost is able to show production if and only if the number of workers and production out of per unit of cost are fixed.
In regards of Hermione's idea, increase in income minus increase in outcome is the increase in net profit. The net profit cannot represent production.
7. The Social Security system provides income for people over age 65. If a recipient of Social Security decides to work and earn some income, the amount he or she receives in Social Security benefits is typically reduced.
- a. How does the provision of Social Security affect people's incentive to save while working?
- b. How does the reduction in benefits associated with higher earnings affect people's incentive to work past age 65?
People after 65 are faced with a trade-off between earning income plus reduced Social Security benefits and regular Social Security benefits only. For people who cannot earn much money by working it is very likely that they choose not to work and rely on Social Security benefits exclusively. Thus for most people the total income will not be quite satisfied, incenting them to save while working. However for people with higher earnings, the decrease in Social Security benefits is much smaller than the earnings. If one makes decision only based on money profit, he/she will chooses to work because the marginal benefit outweighs the marginal cost.
8. A recent bill reforming the government's anti-poverty programs limited many welfare recipients to only 2 years of benefits.
- a. How does this change affect the incentives for working?
- b. How might this change represent a trade-off between equity and efficiency?
a. This change reduces the benefit of not working thus raises the opportunity cost. He who isn't working is faced with two choices: work and not work. The opportunity cost of the former is two years of welfare benefits while that of the latter is constant wages. In this way, the change stimulates people to choose to work.
b. Equity means to allocate resources to all citizens equally while efficiency means to improve productivity. Apparently encouraging people to work can improve efficiency, but limiting welfare benefits to two years reduces the resources allocated to those who are out of work. Therefore the change, in pursue of efficiency, give up some equity.
9. Your roommate is a better cook than you are, but you can clean more quickly than your roommate can. If your roommate did all of the cooking and you did all of the cleaning, would your chores take you more or less time than if you divided each task evenly? Give a similar example of how specialization and trade can make two countries both better off.
Since my roommate is a better cook than I am, I can assume that it takes my roommate 10 mins to cook while it takes me 15 mins. Since I can clean more quickly than my roommate can, I can assume that it takes me 2 mins to clean while it takes my roommate 5 mins. I also assume that if workload doubles then the time doubles too.
- If my roommate did all of the cooking and I did all of the cleaning, then the duration would be 10×2 + 2×2 = 24 mins.
- If we divided each task evenly, then the duration would be 15 + 2 + 10 + 5 = 32 mins.
So if my roommate did all of the cooking and I did all of the cleaning, our chores would take us less time (24 mins) than if we divided each task evenly (32 mins).
Suppose products X and Y is needed by every country and between country A and B, A is better at producing X while B is better at producing Y. Producing X costs A $100 per unit and B $150 per unit while producing Y costs A $150 per unit and B $100 per unit. Both countries need one unit of X and one unit of Y now.
- If A produces two units of X, B produces two units of Y and A trades one unit of X with B for one unit of Y, then the total costs of the two countries will be the cost of A producing two units of X plus B producing two units of Y equals to $400.
- If they produce what they need separately, then the total costs will be the cost of A producing one unit of X and one unit of Y plus B doing the same equals to $500.
For country A, without specialization and trade, the cost of producing one unit of X and one unit of Y is $250; however, with specialization and trade, it produces two units of X which costs $200 then give one unit of X to get one unit of Y, achieving the same result. The price of Y may rise about its cost in country B which is $100, but as long as it is below the cost in country A which is $150, the trade makes each countries better off. For B it is all the same.
10. Suppose the United States adopted central planning for its economy, and you became the chief planner. Among the millions of decisions that you need to make for next year are how many compact discs to produce, what artists to record, and who should receive the discs.
- a. To make these decisions intelligently, what information would you need about the compact disc industry? What information would you need about each of the people in the United States?
- b. How would your decisions about CDs affect some of your other decisions, such as how many CD players to make or cassette tapes to produce? How might some of your other decisions about the economy change your views about CDs?
My goal is to make the benefit outweigh the opportunity cost. Suppose I am going to produce CD in quantity A. The opportunity cost is the value of other products that can be made with the resources given to the production of CD, which, I guess, can be calculated in the prices of resources and therefore is the monetary cost - suppose it is X. The benefit is the value of product measured in the price of CDs and therefore is the monetary benefit - suppose it is Y.
Then my goal is to make sure that Y is no less than X.
Y = quantity produced × average price
X = quantity produced × average cost
Net Profit = quantity produced × (average price - average cost)
Thus, I need to know the average price and cost. Assume that the average cost is fixed as m. Price, however, changes with the quantity produced - the more we produced, the lower the price. Assume the price is a univariate function of quantity, then the Net Profit is also a univariate function of quantity.
Net Profit =- f(x) (x represents the quantity produced)
I need to draw a graph of f(x) and find the peak in order to know how many CDs to produce. To draw the graph I can use the data of last few years.
11. Nations with corrupt police and court systems typically have lower standards of living than nations with less corruption. Why might that be the case?
Knowing that living standard is determined by productivity, this question can be simplified into "Why do corrupt police and court systems reduce productivity?"
Police and court work to enforce property rights, which is key to the smooth running of market. If a country's police and court systems are corrupt, then benefit of working reduced because it is possible to be lost in many ways. This serves as a negative incentive that prevent people from working and thus reduces productivity.
In a nutshell, nations with corrupt police and court systems typically have lower standards of living than nations with less corruption because corrupt police and court systems discourage people from working so that productivity is reduced.
12. Explain whether each of the following government activities is motivated by a concern about equity or a concern about efficiency, discuss the type of market failure involved.
a. providing unemployment insurances
b. regulating electrical utilities
c. evaluating mergers of American companies
d. operating public health clinics
e. providing national defense
f. instituting fines for firms who pollute
a. It is motivated by a concern about equity and no market failure is involved.
b. It is motivated by a concern about equity and involves positive externality.
c. It is motivated by a concern about efficiency and involves market power.
d. It is motivated by a concern about equity and involves positive externality.
e. It is motivated by a concern about efficiency and involves positive externality.
f. It is motivated by a concern about efficiency and involves negative externality.
13. Discuss each of the following statements from the standpoints of equity and efficiency.
a. "Everyone in society should be guaranteed the best healthcare possible."
b. "When workers are laid off, they should be able to collect unemployment benefits until they find a new job."
- EQUITY - True. Healthcare, as a kind of economic prosperity, should be distributed fairly among the members of society. Since everyone should receive the same, everyone is receiving the best.
- EFFICIENCY - False. If people who can produce more live as long as those who produce less, the general productivity cannot be increased. Moreover, it reduces the opportunity cost of not working, also serving no good as to improve productivity.
- EQUITY - True. No matter people are working or not, they should receive benefits of economic prosperity.
- EFFICIENCY - False. Giving the unemployed money reduces the opportunity cost of not working, serving no good as to improve productivity.
14. 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?
My standard of living is much higher than that of my parents or grandparents when they were my age.
Changes have occurred because productivity have been improving over the generations.
15. Suppose Americans decide to save more of their incomes. If banks lend this extra saving to businesses, which use the funds to build new factories, how might this lead to faster growth in productivity? Who do you suppose benefits from the higher productivity? Is society getting a free lunch?
Suppose the extra saving is $100 and deposit interest rate is 1%; thus one year later Americans can get $101.
Suppose the loan interest rate is 2%; thus one year later businesses should pay back $102.
The businesses use $100 to build new factories. Suppose after a year of use it is then worth $90 and during the year, the factories bring an extra production which worth $50 on a cost of $30. After a year, the businesses make a net profit of 90+20-102= $8. The productivity grows because of the extra production of $50.
From the standpoints of Americans, although they gain $1 after a year of saving, they spent $50 on purchasing the extra products. It is not a free lunch because the purchasing power shrinks.
16. Imagine that you are a policymaker trying to decide whether to reduce the rate of inflation. To make an intelligent decision, what would you need to know about inflation, unemployment, and the trade-off between them?
If I decrease the rate of inflation by releasing less money to the society, the purchasing power will decrease; then demand decreases and unemployment increases.
If I decrease the rate of inflation by lowering the cost like lowering the loan interest rate, the quantity produced will increase to satisfy more need at a lower price. Because the demand increase, unemployment will decrease.
CONFUSED! There should be a trade-off between inflation and unemployment, but here it seems okay to reduce both inflation and unemployment by lowering the cost. What's wrong?
17. Look at a newspaper or at the website http://www.economist.com to find three stories about the economy that have been in the news lately. For each story, identify one (or more) of the Ten Principles of Economics discussed in this chapter that is relevant and explain how it is relevant. Also, for each story, look through this book's Contents and try to find a chapter that might shed light on the news event.
I will do it in the New forum.