Chapter 01 - Thinking Like an Economist

Chapter 1 Thinking Like an Economist

Answers to Questions for Review
1. The opportunity cost of reading a novel this evening is not being able to do whatever you
would have done instead. If you would have watched TV, then your opportunity cost is not
watching TV; if you would have studied economics, then your opportunity cost is not
studying economics.

2. The tuition is a sunk cost and so your roommate should consider only costs and benefits
relevant now and in the future. If he will be better off in life by leaving school now, he should
not let the tuition make the rest of life less meaningful.

3. Driving an automobile (which pollutes the atmosphere) imposes an external cost on others.
Building a house which others admire presents an external benefit. Inventing something
which is new and useful but which cannot be patented presents another external benefit.

4. A 50 year old presumably is in a higher pay bracket than a 20 year old so the opportunity cost
of leaving the job is greater for the older person.

5. By definition, a sunk cost is a cost that is incurred regardless of one's current decisions.

6. Economists generally argue that people act in their own self-interest even if they do not
consistently evaluate costs and benefits. The analogy most frequently used (from Milton
Friedman) is that of a pool player who knows how to sink his shots without having studied
physics.

1-1

Chapter 01 - Thinking Like an Economist

Answers to Chapter 1 Problems

1. Let Rx be the amount Nozipho earns in a day on her job. The cost to Nozipho of going to the
park is then R90 (admission fee) + R30 (petrol & parking) + R60 (the lost satisfaction from
not working) + Rx (lost salary) = R180 +Rx. The benefit of going to the park is R270. She
should go to the park if her salary is R60/day, and shouldn't go if her salary is R120/day. At a
salary of R90/day, she is indifferent between going and not going.

2. If Tom kept the R2 000 and invested it in additional mushrooms, at the end of a year's time
he would have an additional R4 000 worth of mushrooms to sell. Dick must therefore give
Tom R2 000 of interest in order for Tom not to lose money on the loan.

3. It is reasonable to assume that everybody has decreasing satisfaction from each kilogram of
food as consumption level increases. At UWC, everybody will eat until the benefit from
eating an extra kilogram of food is equal to R0, since this is the cost of each kg of food. At
UCT, people will eat until the benefit decreases to R48. Thus, everybody will eat less if they
are at UCT. So, not just average consumption but also each individuals personal
consumption will be lower. Note that to reach this conclusion we need the assumption that
the students at both universities have the same appetites.

4. The only costs that vary with mileage are fuel, maintenance, and tires, which average
R1.60/km. The cost of driving will thus be R1 600, and since this is more than the cost of the
bus, you should go by bus.

5. The band and hall rental fees are fixed costs. The caterers charge at the rate of R130/guest
(R100 catering bill and R30 drink). So an extra 10 guests will increase total costs by only
R1 300.
1-2

Chapter 01 - Thinking Like an Economist

6. You gave up the R400 you would have earned if the money was in your savings account.
This assumes that your tax rate on interest earned is zero.

7. Bill has already bought his ticket, so his cost-benefit calculation when it is time to go is as
follows: benefit of seeing game vs. cost of the drive + time costs, etc. Joe, not having bought
his ticket, faces a different calculation: benefit of seeing game vs. R70 + cost of the drive +
time costs, etc. Since the benefits are the same in each case, but the costs are larger for Joe at
the moment of decision, he is less likely to go.

8. A plane of either type--large or small--should use the state-of-the-art device if the extra
benefits of that device exceed its extra costs. Because the device will save more lives in large
planes than in small planes, its benefits are larger in large planes than in small ones. Your
original recommendation was presumably based on the calculation that the benefits for the
larger planes justified the extra cost, but did not do so in the case of the smaller planes.
Airline passengers are like other people insofar as their willingness to invest in extra safety is
constrained by other pressing uses for their scarce resources. Where extra safety is relatively
cheap, as in large planes, they will rationally choose to purchase more than when it is
relatively more expensive, as in small planes.

9. With more than a week to go, the R600 driver's fee and the R300 bus cancellation fee are
sunk costs. If the trip takes place, the additional costs will be the remaining R2 700 of the
bus fee plus the R450 in tolls, for a total of R3 150 in additional costs. If at least 30 tickets
will be sold, it makes sense to continue the trip, since total revenue (R3 240) will exceed the
additional cost.

1-3

Chapter 01 - Thinking Like an Economist

10. Assuming that residents are required to recycle bags, they simply cannot put them with the
regular trash. In the first case, the fixed cost of R60/week is a sunk cost. Therefore, for the
residents, the cost of disposing an extra bag is R0. In the tag system, the cost of disposing an
extra bag is R10, regardless of the number of bags. Therefore, since the costs are higher and
the benefit of setting out a bag is assumed to be the same in both cases, you expect less bags
to be collected in the tag system.

11. The benefit of the 1st gigabyte is R2 000, the 2nd is R1 000, the 3rd is R500, the 4th is R250,
the 5th is R125, the 6th is R62.50, the 7th is R31.25 and the 8th is 15.63. You should purchase 4
gigabytes. At higher levels of benefit, the benefit is less than the cost. At lower levels, benefit
exceeds the cost.

Price
2 000
Marginal
Benefit (MB)

1 000

500

Marginal Costs (MC)

250
1

1-4

9 Memory (GB)

Chapter 01 - Thinking Like an Economist

12. When the price falls to R125/GB, you consume 5 GB (rather than 4 GB at the higher price.)
When your benefit rises also, you consume 6 GB of RAM.
Price
2 000

MBQ12

The curve to the right MBQ12

shows the new benefit function.
1 000
MBQ11
500
MCQ11
250
125

MCQ12
1

9 Memory (GB)

13. False. The fact that she would have chosen the party before she bought her ticket means that
she prefers a party to an event that costs R120. Now her choice is between two events that
she can attend with no further payment.

14.
Celine Dion

Robbie Williams

Benefit

BCD

BRW

Cost (initial)

R250

R250

Cost (final)

R250

R150

In the problem, we are given that

BCD R250 > BRW R250
or
BCD > BRW

(*)

Now, we need to find out whether the following is true or not:

1-5

Chapter 01 - Thinking Like an Economist

BCD R250 > BRW - R150

which is the same as
BCD > BRW + R100

(**)

Notice that (*) does not necessarily imply (**). For example, if BCD = R280 and BRW = R220,
then (*) holds while (**) does not. So we can conclude that you should not go to the Celine
Dion concert in the above scenario if you are a rational utility maximizer.
Your decision will depend on the relative values of BCD and BRW. The fact that you would
have bought a Celine Dion ticket means that the benefit of attending the Celine Dion concert,
denoted BCD, must be greater than R250. Let BRW denote the benefit of going to the Robbie
Williams concert. The fact that you would have chosen the Celine Dion concert before
receiving your Robbie Williams concert ticket means that BCD > BRW. But this does not
imply that you should go to the Celine Dion concert. Suppose BCD = R280 and BRW = R220.
When you now choose between the two concerts, the opportunity cost of attending the
Robbie Williams concert is R150, so the net benefits of attending each concert are given by
BCD R250 = R30 and BRW R150 = R70, which means you should go to the Robbie
Williams concert. So FALSE.

15. Safari provides R60 000+/yr more enjoyment than an academic job. R420 000 = gross benefit
of business job salary.
Costs of Business Job
60 000 opportunity cost of loan
300 000 lost salary as safari leader
60 000+ lost enjoyment from safari job
R420 000+ total cost of taking of business job > benefit, so don't take the job.

If business salary was R420 001/yr, he would have taken it.

1-6

Chapter 01 - Thinking Like an Economist

16. True. If you got R150 000 for the Focus and paid that plus R50 000 more for the Jetta, the
entire Jetta expense would have cost you R250 000. Since you have already shown that you
did not want the Jetta for R250 000, why would you spend that for it now?

1-7