ECON1001ECON1001

Tutorial 1Tutorial 1

Q.1 The scarcity principle implies that to have more of one thing usually means

a.a. increasing resourcesincreasing resources

b.b. limiting wantslimiting wants

c.c. increasing the need for anotherincreasing the need for another

d.d. having less of anotherhaving less of another

e.e. none of the abovenone of the above

Answer: Answer: dd by definition by definition

Option a:Option a:

if resources can be increased whenever we’ve if resources can be increased whenever we’ve scarcity, there’ll be no need to study economics!scarcity, there’ll be no need to study economics!

Option b:Option b:

come on!! Admit it! Human wants are unlimited!come on!! Admit it! Human wants are unlimited! Option c:Option c:

If you need to increase your desire on B while If you need to increase your desire on B while you’re having more A… you’re facing a more you’re having more A… you’re facing a more severe ‘scarcity’ problem.severe ‘scarcity’ problem.

Q.2 A sunk cost is Q.2 A sunk cost is

a.a. the value of money sunk into investmentthe value of money sunk into investment

b.b. beyond recovery at the moment a decision must be beyond recovery at the moment a decision must be mademade

c.c. important to consider when conducting cost-benefit important to consider when conducting cost-benefit analysisanalysis

d.d. equal to the opportunity cost when the interest equal to the opportunity cost when the interest rate is zerorate is zero

e.e. the same as a marginal costthe same as a marginal cost

Answer: Answer: b b definition definition

(option d does not make sense, designed to confuse (option d does not make sense, designed to confuse you.)you.)

Q.3 When deciding whether to pursue Q.3 When deciding whether to pursue an activity further, which of the an activity further, which of the following cost is relevant?following cost is relevant?

a.a. sunk costssunk costs

b.b. marginal costsmarginal costs

c.c. average costsaverage costs

d.d. total coststotal costs

e.e. fixed costfixed cost

Answer: Answer: bb

KEY: KEY:

When deciding whether to pursue an activity When deciding whether to pursue an activity furtherfurther……

Further = additionalFurther = additional Sunk cost: NOT recoverable at the moment you Sunk cost: NOT recoverable at the moment you

make the decision, i.e. not relevant in deciding make the decision, i.e. not relevant in deciding whether to pursue an activity whether to pursue an activity furtherfurther……

E.g. Isaac, who is the hottest guy among freshmen, E.g. Isaac, who is the hottest guy among freshmen, asked you out AFTER one of the following situations:asked you out AFTER one of the following situations:i.i. you’veyou’ve purchased purchased a a non-refundable non-refundable $40 movie $40 movie ticket.ticket.ii. ii. you’ve you’ve purchased purchased a a non-refundable non-refundable $2000 $2000 Madonna world tour concert ticketMadonna world tour concert ticket

Assuming that the value of going out with Isaac is the Assuming that the value of going out with Isaac is the highest among the 3 activities,highest among the 3 activities,

Will there be Will there be any differencesany differences in your choice under the two in your choice under the two situations?situations?

TC vs AC vs MCTC vs AC vs MC Assume:Assume:

Each Unit can be sold Each Unit can be sold at $6at $6

Starting from zero Starting from zero unit, should you unit, should you produce the 1st unit? produce the 1st unit? 2nd? 3rd?...5th?2nd? 3rd?...5th?

What happen if you What happen if you evaluate the decision evaluate the decision by looking at AC by looking at AC instead?instead?

QQ TC($)TC($) AC($AC($))

MC($MC($))

00 00 00

11 33 33 33

22 77 3.53.5 44

33 1212 44 55

44 2020 55 88

55 3232 6.46.4 1212

Fixed Cost Fixed Cost

= costs that will = costs that will not be variednot be varied with with production production plan/ scaleplan/ scale E.g. Rent, Management fee etcE.g. Rent, Management fee etc

If, in previous example, the factory now faces a If, in previous example, the factory now faces a $10 increase in rent, will it increase/ decrease $10 increase in rent, will it increase/ decrease production plan?production plan?

What if the rent is increased by $10000000?What if the rent is increased by $10000000?

Q.5 In general, rational decision making Q.5 In general, rational decision making requires one to choose the actions that requires one to choose the actions that yield the yield the

a.a. largest total benefit. largest total benefit.

b.b. smallest average cost. smallest average cost.

c.c. smallest total cost. smallest total cost.

d.d. largest economic surplus. largest economic surplus.

e.e. smallest net benefit. smallest net benefit.

Answer: Answer: dd

Economists ADOPTED the Economists ADOPTED the

Cost-Benefit Analysis Cost-Benefit Analysis

in analyzing human behaviorin analyzing human behavior Thus, to know how Thus, to know how action/behavioraction/behavior will will change change

under under different different circumstancescircumstances, we, weneed to calculate BOTH cost AND benefitneed to calculate BOTH cost AND benefit

i.e. we consider ‘net benefit’/ ‘econ surplus’i.e. we consider ‘net benefit’/ ‘econ surplus’ definition:definition:

econ surplus = benefit - costecon surplus = benefit - cost

Q.4 Suppose the most you would be Q.4 Suppose the most you would be willing to pay for a plane ticket home is willing to pay for a plane ticket home is $250, but you buy one online for $175. $250, but you buy one online for $175. The economic surplus of buying the The economic surplus of buying the online ticket is: online ticket is:

a.a. $175. $175.

b.b. $250. $250.

c.c. $75 $75

d.d. $50. $50.

e.e. $0.$0.

Answer: Answer: cc

As defined in Q.5As defined in Q.5

econ surplus = benefit – costecon surplus = benefit – cost The economic surplus of buying the online ticketThe economic surplus of buying the online ticket

= willingness to pay – price= willingness to pay – price Willingness to pay Willingness to pay reflects reflects how much you could how much you could

benefit from the actionbenefit from the action Econ surplus = $250 - $175Econ surplus = $250 - $175

= $75= $75

Q.6 If each unit costs $12, and you can only Q.6 If each unit costs $12, and you can only buy whole units, what is the optimal buy whole units, what is the optimal quantity to purchase? quantity to purchase?

a.a. 11

b.b. 22

c.c. 33

d.d. 55

e.e. 66

Answer: Answer: bb

QQ MB($)MB($)

11 2020

22 1515

33 1010

55 55

77 00

* MB = Marginal Benefits

AssumeAssume1. 1. P=$12/unit P=$12/unit 2. Constant PRICE no matter how many you 2. Constant PRICE no matter how many you buy buy 3. The seller sells ONE UNIT BY ONE UNIT3. The seller sells ONE UNIT BY ONE UNIT4. Each unit is 4. Each unit is homogeneoushomogeneous

QQ MB($)MB($)

11 2020

22 1515

33 1010

55 55

77 00

Define:Define: Economic Surplus = Economic Surplus =

Benefit – costBenefit – cost If you purchase the good If you purchase the good

one unit by one unitone unit by one unit,,

THAT unit’s econ surplusTHAT unit’s econ surplus

= MB - $12= MB - $12 Will you buy the 3rd Will you buy the 3rd

unit?unit?

Now assume the seller Now assume the seller sells them in PACKAGES, sells them in PACKAGES, while unit price is while unit price is constant…constant…

QQ MB($)MB($) Surplus(Surplus($)$)

11 2020 88

22 1515 33

33 1010 -2-2

55 55 -7-7

77 00 -12-12

Additional challengeAdditional challenge If the good is sold in packages:If the good is sold in packages: Package of ONE unitPackage of ONE unit

TOTAL ECON SURPLUSTOTAL ECON SURPLUS= MB ($20) – cost ($12)= MB ($20) – cost ($12)= $8= $8

Package of TWO unitsPackage of TWO unitsTOAL ECON SURPLUSTOAL ECON SURPLUS= MB 1st unit + MB 2nd unit – $12X2= MB 1st unit + MB 2nd unit – $12X2= $11= $11

Calculate all 7 packages Calculate all 7 packages Which package should you buy?Which package should you buy?

Q.7 What would price have to equal before 7 Q.7 What would price have to equal before 7 units would be purchased? units would be purchased?

a.a. 00

b.b. 55

c.c. 1010

d.d. 1515

e.e. 2020

Answer: Answer: aa

QQ MB($)MB($)

11 2020

22 1515

33 1010

55 55

77 00

If each unit costs $x, and your optimal If each unit costs $x, and your optimal quantity to purchase is 7. What is $x?quantity to purchase is 7. What is $x?

How much will you pay for How much will you pay for each uniteach unit if the if the seller sells them to you seller sells them to you one by one one by one ??

e.g. $25 for 1st unit?e.g. $25 for 1st unit?

or $19 for 1st unit?or $19 for 1st unit?

$18 for 2nd unit?$18 for 2nd unit?

or $14.5 for 2nd unit?or $14.5 for 2nd unit?

::

::

$0.000001 for 7th $0.000001 for 7th unit?unit?

or 0 for 7th unit?or 0 for 7th unit?

QQ MB($)MB($)

11 2020

22 1515

33 1010

55 55

77 00

Marginal BenefitMarginal Benefit Additional Additional benefit for having ONE MORE UNITbenefit for having ONE MORE UNIT = max amount of money you’re = max amount of money you’re willing willing to pay to pay

for having for having the the additionaladditional unit unit Note: just an econ concept, NOT directly Note: just an econ concept, NOT directly

observable, observable, but may be estimatedbut may be estimated.. So don’t blame you Sociology classmate for not So don’t blame you Sociology classmate for not

knowing the term in making a purchase decisionknowing the term in making a purchase decision AND, her purchase decision will NOT be AND, her purchase decision will NOT be

irrational/ invalid in economics because she irrational/ invalid in economics because she doesn’t understand the term ‘MB’.doesn’t understand the term ‘MB’.

Although most people do not know the term, Although most people do not know the term, they behave as if they are comparing marginal they behave as if they are comparing marginal benefits to marginal cost in making their benefits to marginal cost in making their decisions.decisions.

Q.8Q.8 Amy is thinking about going to the Amy is thinking about going to the movies tonight. A ticket costs $7 and movies tonight. A ticket costs $7 and she will have to cancel her dog-sitting she will have to cancel her dog-sitting job that pays $30. The cost of seeing job that pays $30. The cost of seeing the movie is the movie is

a.a. $7. $7. b.b. $30. $30. c.c. $37. $37. d.d. $37 minus the benefit of seeing the movie. $37 minus the benefit of seeing the movie. e.e. indeterminate. indeterminate.

Answer: Answer: cc

Opportunity CostOpportunity Cost= Value of best alternative forgone= Value of best alternative forgone

Amy has to forgo i. $7ii. One evening

Oppo. Cost for Amy to go movie= $7 + ‘value of one evening’/’value given by dog sitting’

Oppo. Cost for Amy to go movie= $7 + ‘value of one evening’/’value given by dog sitting’

= explicit cost + implicit cost (implicit = not directly observable)= money cost + time cost

Modification #1Modification #1

IFIF

Amy is thinking about going to the movies Amy is thinking about going to the movies tonight. A ticket costs $7 and she has nothing to tonight. A ticket costs $7 and she has nothing to do that night. The cost of seeing the movie is ?do that night. The cost of seeing the movie is ?

Modification #2Modification #2

IFIFAmy is very popular among friends. Tom gave her a $7 Amy is very popular among friends. Tom gave her a $7 ticket and invited her to movie tonight. At the same titicket and invited her to movie tonight. At the same time, Amy canme, Amy cani.i. go karaoke with Sam. (Sam will pay for her expego karaoke with Sam. (Sam will pay for her expenses, around $40)nses, around $40)ii.ii. Dine with Siu Ming. (Siu Ming’s treat, around $Dine with Siu Ming. (Siu Ming’s treat, around $60)60)

Assuming that the 3 persons are ‘equally handsome’,Assuming that the 3 persons are ‘equally handsome’,

Q.1Q.1 What will she do?What will she do?Q.2Q.2 What is her oppo. cost of going movie?What is her oppo. cost of going movie?Q.3 Q.3 How will your ans in Q.2 change if Siu Ming actuHow will your ans in Q.2 change if Siu Ming actu

ally prepared a surprise gift (Tiffany necklace, $2000) aally prepared a surprise gift (Tiffany necklace, $2000) and Amy didn’t know it until the next day?nd Amy didn’t know it until the next day?

Q.9 Jody has purchased a non-refundable $25 Q.9 Jody has purchased a non-refundable $25 ticket to attend a Savage Garden concert ticket to attend a Savage Garden concert on Friday evening. Subsequently, she is on Friday evening. Subsequently, she is asked to go to dinner and dancing at no asked to go to dinner and dancing at no expense to her. If she uses cost-benefit expense to her. If she uses cost-benefit analysis to choose between going to the analysis to choose between going to the concert and going on the date, she concert and going on the date, she should should

a.a. include only the entertainment value of the concert in the include only the entertainment value of the concert in the opportunity cost of going on the date. opportunity cost of going on the date.

b.b. include the cost of the ticket plus the entertainment value of include the cost of the ticket plus the entertainment value of the concert in the opportunity cost of going on the date. the concert in the opportunity cost of going on the date.

c.c. include only the cost of concert ticket in the opportunity cost include only the cost of concert ticket in the opportunity cost of going on the date. of going on the date.

d.d. include neither the cost of the ticket plus the entertainment include neither the cost of the ticket plus the entertainment value of the concert in the opportunity cost of going on the value of the concert in the opportunity cost of going on the date. date.

e.e. have a psychiatric evaluation because dates cannot be have a psychiatric evaluation because dates cannot be evaluated using cost-benefit analysis.evaluated using cost-benefit analysis.

Answer: Answer: aa

DECISION: DECISION: Concert VS DateConcert VS Date

Oppo. Cost of going concert Oppo. Cost of going concert = give up ‘net’ economic surplus of date= give up ‘net’ economic surplus of date= value of date – expected expenses of date= value of date – expected expenses of date= ‘value’ – zero (‘dancing at = ‘value’ – zero (‘dancing at no expenseno expense to her’) to her’)

Oppo. Cost of going dateOppo. Cost of going date= give up ‘net’ economic surplus of concert= give up ‘net’ economic surplus of concert= value of concert – expected expenses of concert= value of concert – expected expenses of concert= ‘value’ – ?????? $25???= ‘value’ – ?????? $25???

SHOULD YOU PUT IN THE COST OF TICKET!? ($25)SHOULD YOU PUT IN THE COST OF TICKET!? ($25)

SUNK COSTSSUNK COSTS are costs that are costs that

- have already been incurred- have already been incurred

- cannot be recovered at that moment when - cannot be recovered at that moment when you’re making decisionsyou’re making decisions

Does that ‘$25’ fit in the above definitions?Does that ‘$25’ fit in the above definitions?

THEREFORETHEREFORE Oppo. Cost of going dateOppo. Cost of going date

= give up ‘net’ economic surplus of concert= give up ‘net’ economic surplus of concert= value of concert – expected ADDITIONAL expenses of = value of concert – expected ADDITIONAL expenses of concertconcert= ‘value’ – = ‘value’ – zerozero

Try to analyze the question AGAIN by using MARGINTry to analyze the question AGAIN by using MARGINAL Value/CostAL Value/Cost

IFIF

the ticket is the ticket is fully fully refundablerefundable, how would it , how would it affect Jody’s decision?affect Jody’s decision?

IFIF

the ticket isthe ticket is refundable at a discounted pricerefundable at a discounted price, , how would it affect Jody’s decision?how would it affect Jody’s decision?

Q.10 If the government wanted to use Q.10 If the government wanted to use the incentive principle to discourage the incentive principle to discourage smoking, it would smoking, it would a.a. publicize the health risks associated with publicize the health risks associated with

second-hand smoke. second-hand smoke. b.b. increase taxes on cigarettes, raising the price of increase taxes on cigarettes, raising the price of

a pack. a pack. c.c. subsidize tobacco companies. subsidize tobacco companies. d.d. subsidize hospitals for treating lung disease. subsidize hospitals for treating lung disease. e.e. invest more money in health research. invest more money in health research.

Answer: Answer: bb

Most Most DIRECTDIRECT way to reduce smoking: way to reduce smoking: Raise Price of cigarettesRaise Price of cigarettes DISCOURAGE CONSUMPTIONDISCOURAGE CONSUMPTION

Can be done by option b:Can be done by option b:impose impose taxtax on on producersproducers= increase production costs= increase production coststhe market needs a higher market price to the market needs a higher market price to support the productionsupport the production(common sense argument) (common sense argument)

Option c & d: contradict to answerOption c & d: contradict to answer C: subsidize tobacco companiesC: subsidize tobacco companies

encourage productionsencourage productions D: subsidize hospitals for treating lung disease.D: subsidize hospitals for treating lung disease.

lower opportunity cost to smoke, lower opportunity cost to smoke, encourage consumption encourage consumption

Option a & e:Option a & e: also discourage smokersalso discourage smokers but results NOT as direct as imposing taxes but results NOT as direct as imposing taxes

on producerson producers reduce production + reduce production + consumptionconsumption

EndEnd