Eco 201 Name_______________________________ Problem Set 1 2 June 2009 Frank & Bernanke, Chapter 1: Marginal and Sunk Costs 1. The most you would be willing to pay for having a freshly washed car before going out on a date is $6. The smallest amount for which you would be willing to wash someone else's car is $3.50. You are going out this evening, and your car is dirty. How much economic surplus would you receive from washing it? 2. To earn extra money in the summer, you grow tomatoes and sell them at the farmers' market for 30 cents per pound. By adding compost to your garden, you can increase your yield as shown in the table below. If compost costs 50 cents per pound and your goal is to make as much money as possible, how many pounds of compost should you add? Pounds of compost Pounds of tomatoes 0 100 1 120 2 125 3 128 4 130 5 131 6 131.5 3. Residents of your city are charged a fixed weekly fee of $6 for garbage collection. They are allowed to put out as many cans as they wish. The average household disposes of three cans of garbage per week under this plan. Now suppose that your city changes to a "tag" system. Each can 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.4. 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 Interest 2000 Fuel and Oil 1200 Tires 200 License and Registration 50 Maintenance 1100 Total 5550 Should you drive or take the bus? 5. 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? 6. Down on Our Luck Studios has spent $100 million producing an awful film, A Depressing Story about a Miserable Person. If the studio releases the film, the most cost-effective marketing plan would cost an additional $5 million, bringing the total amount spent to $105 million. Box office sales under this plan are predicted to be $12 million, which would be split evenly between the theaters and the studio. Additional studio revenue from video and DVD sales would be about $2 million. Should the studio release the film? If no, briefly explain why not. If yes, explain how it could make sense to release a film that cost $105 million but earns only $12 million.7. 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? 8. Hatcher Thatcher Baxter III, a recent Wofford graduate, decided early this year to invest in a 2006 model $70,000 BMW sport coupe. He was able to trade in his 1999 Toyota Celica for $5,000. At the time, interest rates on auto loans were 8%, but Hatcher had the option of paying cash, having recently inherited a tidy sum from his grandfather (you guessed it, Hatcher Thatcher Baxter I). Hatcher could have earned 2% on his money if he had left it in a money market fund. Calculate below the estimated opportunity cost per year to Hatcher of upgrading from the Toyota to the BMW: Annual Interest Cost (Base this on Hatcher's best course of action.) Annual Depreciation Cost (The resale value of the Toyota would have fallen by $1,000 this year, but the BMW will fall in value by $7,500 in this first year of ownership.) Annual Registration with the DMV (The Toyota would have cost $150, but the BMW will cost $300.) Annual Automobile Insurance (The Toyota would have cost $800, but the BMW will cost $1600 per year) Annual Estimated Maintenance Expenses (The Toyota would have cost $400, but the BMW will cost $800.) Annual Turtle Wax and Armor-All Expenses (The Toyota would have cost $25, but the BMW will cost $75) Total Annual Estimated Opportunity Cost of Upgrading from Toyota to