Harcourt,Inc.itemsandderiveditemscopyright2001byHarcourt,Inc.1)ProblemsandApplications1.a.Afamilydecidingwhethertobuyanewcarfacesatradeoffbetweenthecostofthecarandotherthingstheymightwanttobuy.Forexample,buyingthecarmightmeantheymustgiveupgoingonvacationforthenexttwoyears.Sotherealcostofthecaristhefamily'sopportunitycostintermsofwhattheymustgiveup.b.ForamemberofCongressdecidingwhethertoincreasespendingonnationalparks,thetradeoffisbetweenparksandotherspendingitemsortaxcuts.Ifmoremoneygoesintotheparksystem,thatmaymeanlessspendingonnationaldefenseoronthepoliceforce.Or,insteadofspendingmoremoneyontheparksystem,taxescouldbereduced.c.Whenacompanypresidentdecideswhethertoopenanewfactory,thedecisionisbasedonwhetherthenewfactorywillincreasethefirm'sprofitscomparedtootheralternatives.Forexample,thecompanycouldupgradeexistingequipmentorexpandexistingfactories.Thebottomlineis:Whichmethodofexpandingproductionwillincreaseprofitthemost?d.Indecidinghowmuchtoprepareforclass,aprofessorfacesatradeoffbetweenthevalueofimprovingthequalityofthelecturecomparedtootherthingsshecoulddowithhertime,suchasworkingonadditionalresearch.2.Whenthebenefitsofsomethingarepsychological,suchasgoingonavacation,itisn'teasytocomparebenefitstocoststodetermineifit'sworthdoing.Buttherearetwowaystothinkaboutthebenefits.Oneistocomparethevacationwithwhatyouwoulddoinitsplace.Ifyoudidn'tgoonvacation,wouldyoubuysomethinglikeanewsetofgolfclubs?Thenyoucandecideifyou'dratherhavethenewclubsorthevacation.Asecondwayistothinkabouthowmuchworkyouhadtodotoearnthemoneytopayforthevacation;thenyoucandecideifthepsychologicalbenefitsofthevacationwereworththepsychologicalcostofworking.3.Ifyouarethinkingofgoingskiinginsteadofworkingatyourpart-timejob,thecostofskiingincludesitsmonetaryandtimecosts,plustheopportunitycostofthewagesyou'regivingupbynotworking.Ifthechoiceisbetweenskiingandgoingtothelibrarytostudy,thenthecostofskiingisitsmonetaryandtimecostsplusthecosttoyouofgettingalowergradeinyourcourse.4.Ifyouspend$100nowinsteadofinvestingitforayearandearning5percentinterest,youaregivinguptheopportunitytospend$105ayearfromnow.Theideathatmoneyhasatimevalueisthebasisforthefieldoffinance,thesubfieldofeconomicsthathastodowithpricesoffinancialinstrumentslikestocksandbonds.5.Thefactthatyou'vealreadysunk$5millionisn'trelevanttoyourdecisionanymore,sincethatmoneyisgone.Whatmattersnowisthechancetoearnprofitsatthemargin.Ifyouspendanother$1millionandcangeneratesalesof$3million,you'llearn$2millioninmarginalprofit,soyoushoulddoso.Youarerighttothinkthattheprojecthaslostatotalof$3million($6millionincostsandonly$3millioninrevenue)andyoushouldn'thavestartedit.That'strue,butifyoudon'tspendtheadditional$1million,youwon'thaveanysalesandyourlosseswillbe$5million.Sowhatmattersisnotthetotalprofit,buttheprofityoucanearnatthemargin.Infact,you'dpayupto$3milliontocompletedevelopment;anymorethanthat,andyouwon'tbeincreasingprofitatthemargin.6.Harrysuggestslookingatwhetherproductivitywouldriseorfall.Productivityiscertainlyimportant,sincethemoreproductiveworkersare,thelowerthecostpergallonofpotion.Harrywantstolookataveragecost.ButbothHarryandRonaremissingtheothersideoftheequationrevenue.Afirmwantstomaximizeitsprofits,soitneedstoexaminebothcostsandrevenues.Thus,Hermioneisrightit’sbesttoexaminewhethertheextrarevenuewouldexceedtheextracosts.Inaddition,Hermioneistheonlyonewho’sthinkingatthemargin.7.a.Sinceapersongetsfewerafter-taxSocialSecuritybenefitsthegreaterishisorherincome,there'sanincentivenottosaveforretirement.Ifyousavealot,yourincomewillbehigher,andyouwon'tgetasmuchafter-taxSocialSecurityincomeassomeonewhodidn'tsaveasmuch.TheunintendedconsequenceofthetaxationofSocialSecuritybenefitsistoreducesaving;yettheSocialSecuritysystemarosebecauseofworriesthatpeoplewouldn’tsaveenoughforretirement.b.Forthesamereason,you'lltendnottowork(ornotworkasmuch)afterage65.Themoreyouwork,theloweryourafter-taxSocialSecuritybenefitswillbe.ThusthetaxationofSocialSecuritybenefitsdiscouragesworkeffortafterage65.8.a.Whenwelfarerecipientswhoareabletoworkhavetheirbenefitscutoffaftertwoyears,theyhavegreaterincentivetofindjobsthaniftheirbenefitsweretolastforever.b.Thelossofbenefitsmeansthatsomeonewhocan'tfindajobwillgetnoincomeatall,sothedistributionofincomewillbecomelessequal.Buttheeconomywillbemoreefficient,sincewelfarerecipientshaveagreaterincentivetofindjobs.Thusthechangeinthelawisonethatincreasesefficiencybutreducesequity.9.Byspecializingineachtask,youandyourroommatecanfinishthechoresmorequickly.Ifyoudividedeachtaskequally,itwouldtakeyoumoretimetocookthanitwouldtakeyourroommate,anditwouldtakehimmoretimetocleanthanitwouldtakeyou.Byspecializing,youreducethetotaltimespentonchores.Similarly,countriescanspecializeandtrade,makingbothbetteroff.Forexample,supposeittakesSpanishworkerslesstimetomakeclothesthanFrenchworkers,andFrenchworkerscanmakewinemoreefficientlythanSpanishworkers.ThenSpainandFrancecanbothbenefitifSpanishworkersproducealltheclothesandFrenchworkersproduceallthewine,andtheyexchangesomewineforsomeclothes.10.a.Beingacentralp