Review of Chapter 2
Chapter 02 - Economists’ View Of Behavior
CHAPTER 2
REVIEW QUESTIONS
2–1. Which costs are pertinent to economic decision making? Which costs are not relevant? The marginal (incremental) costs and benefits are pertinent to economic decision making. Sunk costs and benefits are not relevant. In economics,
“bygones are forever bygones.”
2-3. The Solace Company has an inventory of steel that it originally purchased for
$20,000. It currently has an offer to sell the steel for $30,000. Should Solace’s management agree to sell? Explain.
You cannot answer this question without additional information. The historic cost of the steel is irrelevant. What is important is the current opportunity cost of the steel. For example, if the current market price of steel is $40,000 you should not sell the steel for $30,000.
2-4. Suppose that you have $900 and what to invest the money for one year. There are three existing options.
(a) The city of Rochester is selling bonds at $90 per unit. The bonds pay $100 at the end of one year when they mature (no other cash flows).
(b) Put the money under your mattress.
(c) The one-year interest rate of saving in the Chase Bank is 7 percent.
Which one will you choose? What is the opportunity cost of your choice? Explain.
Choose option (a). By definition, opportunity cost is the value of the bestforegone option. So the opportunity cost of (a) is the value of (c) in this case, $63 = $900 ×7%.
2-1
Chapter 02 - Economists’ View Of Behavior
2-5. Suppose Juan’s utility function is given by U = FC, where F and C are the two goods available for purchase: food and clothing.
a. Graph Juan’s indifference curves for the following levels of utility: 100, 200, and 300.
Juan’s indifference curves for U = 100, 200 and 300 are pictured as follows. The general formula for the graph of an indifference curve for a given level of utility, U*, is F=U*/C (since U* = F x C). For example, the indifference curve for U* = 100 is
CHAPTER 2
REVIEW QUESTIONS
2–1. Which costs are pertinent to economic decision making? Which costs are not relevant? The marginal (incremental) costs and benefits are pertinent to economic decision making. Sunk costs and benefits are not relevant. In economics,
“bygones are forever bygones.”
2-3. The Solace Company has an inventory of steel that it originally purchased for
$20,000. It currently has an offer to sell the steel for $30,000. Should Solace’s management agree to sell? Explain.
You cannot answer this question without additional information. The historic cost of the steel is irrelevant. What is important is the current opportunity cost of the steel. For example, if the current market price of steel is $40,000 you should not sell the steel for $30,000.
2-4. Suppose that you have $900 and what to invest the money for one year. There are three existing options.
(a) The city of Rochester is selling bonds at $90 per unit. The bonds pay $100 at the end of one year when they mature (no other cash flows).
(b) Put the money under your mattress.
(c) The one-year interest rate of saving in the Chase Bank is 7 percent.
Which one will you choose? What is the opportunity cost of your choice? Explain.
Choose option (a). By definition, opportunity cost is the value of the bestforegone option. So the opportunity cost of (a) is the value of (c) in this case, $63 = $900 ×7%.
2-1
Chapter 02 - Economists’ View Of Behavior
2-5. Suppose Juan’s utility function is given by U = FC, where F and C are the two goods available for purchase: food and clothing.
a. Graph Juan’s indifference curves for the following levels of utility: 100, 200, and 300.
Juan’s indifference curves for U = 100, 200 and 300 are pictured as follows. The general formula for the graph of an indifference curve for a given level of utility, U*, is F=U*/C (since U* = F x C). For example, the indifference curve for U* = 100 is