Eco 201 Name_______________________________ Problem Set 1 8 September 2011 Cowen & Tabarrok, Chapter 1: The Big Ideas 1. A headline1 in the New York Times read:“Study Finds Enrollment Is Up at Colleges Despite Recession.” How would you rewrite this headline now that you understand the idea of opportunity cost? The easiest change is to switch “despite” to “because of.” Ordinary people focus on the fact that when times are tough, people can’t afford college: Economists see that there is an opposing effect, when times are tough the price (or opportunity cost) of attending college is low. There’s some truth to both viewpoints—it’s tough for you or your parents to pay for tuition when jobs are hard to come by and income is low—but as you learned, in the real world it’s actually quite common for students to flood the colleges during recessions. That means that the price effect usually dominates (the income effect). 2. When bad weather in India destroys the crop harvest, does this sound like a fall in the total “supply” of crops or a fall in people’s “demand” for crops? Keep your answer in mind as you learn about economic booms and busts later on. It sounds like a fall in supply. Later on in the text we will be explaining how business fluctuations can be caused by shocks to demand or shocks to supply. 3. Who has a better incentive to work long hours in a laboratory researching new cures for diseases: a scientist who earns a percentage of the profits from any new medicine she might invent, or a scientist who will get a handshake and a thank you note from her boss if she invents a new medicine? The scientist who gets a share of the profits will have a stronger incentive to invent more new drugs. 4. Some people worry that machines will take jobs away from people, making people permanently unemployed. In the United States, only 150 years ago most people were farmers. Now, machines do almost all of the farm work and fewer than 2 percent of Americans are farmers, yet that 2 percent produces enough food to feed the entire country while still exporting food overseas. a. What happened to all of those people who used to work on farms? Do you think most adult males in the U.S. are unemployed nowadays, now that the farm work is gone? b. Some people say that it’s okay for machines to take jobs, since we’ll get jobs fixing the machines. Just from looking around, do you think that most working Americans are earning a living by fixing farm equipment? If not, what do you think most working people are doing instead? a. They are mostly employed in other industries. Farm states don’t have tens of millions of people searching for jobs. b. Very few people fix farm equipment for a living. Instead, they work in offices, warehouses, and factories. The demand for more goods and services is almost limitless so when innovations make it possible to produce a good with fewer resources that frees up those resources (including labor) to produce other goods.5. Suppose that in the last few seconds you devoted to question 1 on your physics exam you earned 4 extra points, while in the last few seconds you devoted to question 2 you earned 10 extra points. You earned a total of 48 and 12 points, respectively, on the two questions, and the total time you spent on each was the same. If you could take the exam again, how—if at all—should you reallocate your time between these questions? Even though you earned four times as many points from the first question than from the second, the last minute you spent on question 2 added 6 more points to your total score than the last minute you spent on question 1. That means you should have spent more time on question 2. Despite downturn and dire outlook for factories, value of American-made goods still leads world. The U.S. by far remains the world's leading manufacturer by value of goods produced. It hit a record $1.6 trillion in 2007 -- nearly double the $811 billion in 1987. For every $1 of value produced in China's factories, America generates $2.50. http://mjperry.blogspot.com/2009/02/made-in-usa-alive-and-well.html6. Residents of your city are charged a fixed weekly fee of $6 for garbage collection. They are allowed to put out as many bags as they wish. The average household disposes of three bags of garbage per week under this plan. Now suppose that your city changes to a "tag" system. Each bag of refuse to be collected must have a tag affixed to it. The tags cost $2 each and are not reusable. What effect do you think the introduction of the tag system will have on the total quantity of garbage collected in your city? Explain briefly. In the first case, the cost is $6/week no matter how many cans you put out, so the cost of disposing of an extra can of garbage is $0. Under the tag system, the cost of putting out an extra can is $2, regardless of the number of the cans. Since the relevant costs are higher under the tag system, we would expect this system to reduce the number of cans collected. 7. You are planning a 1000-mile trip to Kansas. Except for the matter of cost, you are completely indifferent between driving and taking the bus. Bus fare is $260. The costs of operating your car during a typical 10,000-mile driving year are as follows: Insurance $1000 0 Interest 2000 0 Fuel and Oil 1200 120 Tires 200 20 License and Registration 50 0 Maintenance 1100 110 Total 5550 250 Should you drive or take the bus? You should drive because it is $10 cheaper. 8 Al and Jane have rented a banquet hall to host a party in celebration of their wedding anniversary. Fifty people have already accepted their invitation. Given that many people, the caterers will charge $400 for food and $100 for drinks. The band will cost $300 for the evening, and the hall costs $200. Now Al and Jane are considering inviting 10 more people. By how much will these extra guests increase the cost of their party? Marginal cost of inviting 10 more people is $100. 9. A group has chartered a bus to New York City. The driver costs $100, the bus costs $500, and tolls will cost$75. The driver’s fee is nonrefundable, but the bus may be canceled a week in advance at a charge of only $50. At $18 per ticket, how many people must buy tickets so that the trip will not be canceled? Of the $675 in costs, $525 is recoverable if the trip is cancelled, and thus represents an opportunity cost, while $150 is sunk. Thus,