Chapter Number 1

Questions For Review:

1. Trade-offs in life:

o Studying vs. hanging out with friends.

o Spending money on a vacation vs. saving for the future.

o Working extra hours vs. spending time with family.

2. Opportunity cost of a trip to an amusement park:

Include the ticket price, travel costs, food, and the value of your time (what you could have done instead).

3. Marginal benefit of a glass of water:

It depends! If you’re thirsty, the first glass has a large benefit. But after a few glasses, the benefit becomes
small.

4. Why policymakers should think about incentives:

Incentives influence behavior. Policies can encourage good actions (like recycling) or discourage bad ones
(like pollution).

5. Why trade isn’t a win-lose game:

Trade benefits both countries by allowing them to specialize and get goods they can’t produce efficiently.

6. What the “invisible hand” does:

It guides markets to allocate resources efficiently through prices, without central control.

7. Causes of market failure:

o Externalities: Costs or benefits affecting others (e.g., pollution).

o Market power: A single firm controlling prices (e.g., a monopoly).

8. Why productivity is important:

Higher productivity means more goods and services are produced, improving living standards.

9. What is inflation, and what causes it?

Inflation is rising prices. It’s caused by too much money supply, high demand, or increased production
costs.

10. Inflation and unemployment in the short run:

Increasing money supply can boost spending, reduce unemployment, but may lead to higher inflation.
Question1: a. A family deciding whether to buy a car
• Cost vs. Convenience: Buying a car offers convenience but comes with costs such as the purchase
price, fuel, maintenance, insurance, and registration fees.

• New vs. Used: A new car has fewer repairs but is more expensive, while a used car is cheaper but
may require more maintenance.

• Public Transport vs. Private Vehicle: Relying on public transport may save money but might be
less convenient.

b. A member of Congress deciding how much to spend on national parks

• Environmental Benefits vs. Budget Constraints: More spending improves park maintenance,
conservation, and tourism, but takes funds away from other priorities such as healthcare,
education, or defense.

• Short-Term vs. Long-Term Gains: Investing in parks can boost tourism revenue and
environmental sustainability in the long run but may not yield immediate political benefits.

c. A company president deciding whether to open a new factory

• Expansion vs. Risk: A new factory can increase production and revenue but requires a large
investment and may not guarantee profits.

• Domestic vs. International Location: Building a factory domestically may support local jobs but
could be more expensive than outsourcing to a lower-cost country.

• Technology vs. Workforce: Investing in automation can reduce labor costs but may require a
higher initial investment.

d. A professor deciding how much to prepare for class

• Quality of Teaching vs. Time Management: More preparation can lead to better lectures but
takes time away from research, administrative duties, or personal life.

• Depth vs. Breadth: Focusing on in-depth material may engage students more but might limit
coverage of broader topics.

e. A recent college graduate deciding whether to go to graduate school

• Higher Future Earnings vs. Immediate Income: Graduate school can lead to better job
opportunities and salaries but delays earning money and may require student loans.

• Career Specialization vs. Flexibility: Graduate school may provide expertise in a specific field but
might limit job opportunities outside that area.

• Work Experience vs. Education: Gaining work experience immediately may provide practical
skills, whereas graduate school enhances academic qualifications.
f. A single parent with small children deciding whether to take a job

• Income vs. Childcare Costs: A job provides financial stability but may come with high childcare
expenses.

• Time with Children vs. Career Advancement: Working may reduce time spent with children, but
it could also provide long-term career growth and financial security.

• Flexible Work vs. Higher Pay: A high-paying job may require longer hours, while a flexible job
might offer better work-life balance but lower pay.

1. Question2: Monetary Costs – Calculate the total cost of the vacation, including:
o Airfare

o Hotel and accommodations

o Food and entertainment

o Forgone wages (if taking unpaid leave)

2. Psychological Benefits – Although these are harder to quantify, you can assess them based on:

o Stress Reduction: Will the vacation help you relax and recharge?

o Happiness & Enjoyment: Will you experience joy from new experiences, food, culture, or
activities?

o Personal Growth: Will you gain valuable experiences, memories, or skills?

o Social Benefits: Will the trip strengthen relationships with family or friends?

3. Assign a Value to the Benefits – Even though psychological benefits don’t have a direct dollar value, you
can estimate their worth by considering:

o Comparable alternatives: If you spend the same money on something else (e.g., a staycation or a
hobby), would you get the same satisfaction?

o Willingness to Pay: If you’re willing to spend a certain amount for relaxation or happiness, that
can indicate the trip’s value.

o Past Experiences: Have previous vacations significantly improved your well-being? If so, this one
might do the same.

4. Compare Costs vs. Benefits –

o If the psychological benefits outweigh the costs, then the vacation is worth it.

o If the costs seem excessive compared to alternative ways to achieve similar benefits, you might
reconsider or modify the trip (e.g., a shorter or more budget-friendly vacation).
Ultimately, the decision depends on how much you value relaxation, happiness, and experiences versus the
financial trade-offs. If the benefits justify the cost for you, then the vacation is a good investment in your well-
being.

Question:3 Scenario 1: You were planning to work at your part-time job

• Opportunity Cost: The wages you would have earned at work.

• Total Cost of Skiing:

o The cost of the ski trip (e.g., lift ticket, equipment rental, transportation, food).

o The lost income from not working.

Example: If you would have earned $100 at your job and the ski trip costs $150, the total cost is $250.

Scenario 2: You were planning to study at the library

• Opportunity Cost: The potential benefits of studying, such as better grades, improved knowledge, and
long-term career opportunities.

• Total Cost of Skiing:

o The cost of the ski trip (same as before).

o The potential impact of skipping studying (e.g., lower test scores, stress from catching up).

Key Difference: Unlike lost wages (which have a clear dollar value), the cost of skipping studying is harder to
quantify. However, if studying improves your grades and helps you secure a better job in the future, the long-term
financial impact could be significant.

Conclusion:

• If you were skipping work, the true cost is mainly the lost wages plus ski expenses.

• If you were skipping studying, the true cost depends on how much studying helps you achieve your
academic and career goals.

Question4: The opportunity cost of spending the $100 now is the value of what you give up by not saving it in
the bank.

If you deposit the $100 in a bank account that pays 5% interest per year, in one year you would have:

100×(1.05)=105

So, the opportunity cost of spending the $100 now is the $5 in interest you would have earned by saving it instead.

In simple terms, by spending the money now, you are giving up the chance to have $105 in a year instead of just
$100 today.

Question5: Key Points:

• Sunk Cost: The $5 million already spent is irrelevant to the decision because it cannot be recovered.
 • Relevant Costs: The only cost that matters now is the additional $1 million needed to complete
development.

• Expected Revenue: The new expected sales are $3 million.

Decision:

• If you complete the product, the total revenue will be $3 million, and the additional cost to finish is $1
million.

• This results in a net gain of:

3 million−1 million=2 million profit3 \text{ million} - 1 \text{ million} = 2 \text{ million
profit}3 million−1 million=2 million profit

• Since the expected revenue ($3 million) exceeds the additional cost ($1 million), you should complete
the product.

Maximum Amount You Should Pay to Finish Development:

• You should be willing to pay up to $3 million to complete the product because anything beyond that
would mean spending more than you can earn.

• If the cost to finish exceeded $3 million, the project would result in a loss, and you should abandon it.

Question6: a. How did this change affect the incentives for working?
The 1996 welfare reform (Personal Responsibility and Work Opportunity Reconciliation Act) placed a two-year limit
on benefits, which significantly changed work incentives:

• Increased Incentive to Work: Since welfare was no longer an indefinite safety net, recipients had stronger
motivation to find employment before their benefits expired.

• Reduced Dependency on Welfare: The policy aimed to encourage self-sufficiency by discouraging long-
term reliance on government assistance.

• Potential Negative Effects: Some individuals who struggled to find jobs (due to lack of skills, childcare
needs, or job market conditions) may have faced financial hardship once benefits ended.

b. How might this change represent a trade-off between equality and efficiency?

• Equality: Welfare programs promote equality by providing financial assistance to low-income individuals.
However, limiting benefits means that some vulnerable individuals might struggle more, increasing
inequality.

• Efficiency: The policy aimed to improve economic efficiency by reducing government spending on welfare
and encouraging labor force participation, leading to higher productivity and economic growth.

• Trade-Off: Stricter limits on welfare can reduce equality (as some individuals may fall into deeper poverty)
while potentially increasing efficiency (by reducing government expenditures and encouraging work).

Conclusion: The reform prioritized economic efficiency over absolute equality, aiming to reduce welfare
dependency while potentially increasing financial difficulties for those unable to find stable employment.
7. Government Activities: Equality or Efficiency?

a. Regulating cable TV prices:

• Efficiency: The government steps in to prevent cable companies from charging too much. This is because
cable companies might have too much power (market power) and could overcharge customers if there’s
no competition.

• Market failure: Market power (a single company or a few companies control prices).

b. Providing food vouchers to low-income people:

• Equality: This is about fairness. The government helps low-income families afford food, reducing the gap
between rich and poor.

• Efficiency: Not the main goal here, but it could indirectly improve efficiency by ensuring people are
healthy enough to work.

c. Prohibiting smoking in public places:

• Efficiency: Smoking in public harms others (secondhand smoke), which is a negative externality. The
government steps in to protect people from harm caused by others.

• Market failure: Externality (one person’s actions harm others).

d. Breaking up Standard Oil:

• Efficiency: Standard Oil had too much control over the oil market (a monopoly). Breaking it up encourages
competition, which is better for consumers.

• Market failure: Market power (one company dominates the market).

e. Higher income tax rates on the wealthy:

• Equality: This is about fairness. The government takes more from those who can afford it to help those
who are less well-off.

• Efficiency: Not the main goal, but it could reduce inequality, which might lead to a more stable society.

f. Laws against drunk driving:

• Efficiency: Drunk driving puts others at risk, which is a negative externality. The government steps in to
protect people from harm.

• Market failure: Externality (one person’s actions harm others).

8. Equality vs. Efficiency

a. “Everyone should get the best healthcare”:

• Equality: This is about fairness. Everyone, regardless of income, should have access to good healthcare.
 • Efficiency: Providing the best healthcare for everyone could be very expensive. If resources are limited, it
might lead to inefficiency (e.g., long wait times or high taxes).

b. “Unemployment benefits until a new job is found”:

• Equality: This is about fairness. People who lose their jobs should have some support while they look for a
new one.

• Efficiency: If unemployment benefits are too generous, some people might not look for work as quickly,
which could reduce productivity and economic growth.

9. Standard of Living Compared to Parents/Grandparents

• Differences:

o Technology: You have smartphones, the internet, and advanced medical treatments that your
parents or grandparents didn’t have.

o Education: More people have access to higher education today.

o Goods and services: You have access to more variety and better-quality products (e.g., cars,
electronics, food).

• Why:

o Economic growth: Over time, economies have grown, leading to higher incomes and better living
standards.

o Technological progress: Advances in technology have made life easier and more comfortable.

o Globalization: Trade with other countries has made more goods and services available at lower
prices.

10. Saving More and Productivity Growth

• How it works:

o If people save more, banks have more money to lend to businesses.

o Businesses use this money to build new factories, buy better equipment, or invest in technology.

o These investments make workers more productive (they can produce more goods and services in
less time).

• Who benefits:

o Workers: They might get higher wages because they’re more productive.

o Businesses: They make more profits because they can produce more.

o Consumers: They get better and cheaper products.

 • Free lunch?: No, because saving means people are spending less now. They’re sacrificing current
consumption for future benefits.

11. Inflation Tax During the Revolutionary War

• What happened:

o The American colonies needed money to fund the war, but they couldn’t raise enough through
taxes.

o So, they printed more money to pay for things.

• Who is taxed?:

o Everyone who holds money. When more money is printed, the value of each dollar goes down
(inflation).

o This means people’s savings and income buy less than before, which is like a hidden tax.

• Why?:

o Printing too much money reduces its value, so people effectively lose purchasing power. This is
how the government “taxes” people without officially raising taxes.