Transcript ECON 1001 AB Introduction to Economics I Dr. Ka

ECON 1001 AB
Introduction to Economics I
Dr. Ka-fu WONG
First week of tutorial sessions
KKL 925
Clifford CHAN
KKL 1109
[email protected]
Covered and to be covered
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Covered last week
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Dr. Wong covered up to #63 of kf001.ppt
You should have at least read up to Chapter 1
Thinking like an economist. If not, please press
hard on it. Don’t pile all the readings until exam
period!
Start reading chapter 2 and 3
To be covered in tutorial sessions this week
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Problems in chapter 1: #1, #3, #5, #7 and #9
You are advised to work on the even ones as well
Problem #1, Chapter 1
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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 of
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?
Solution to problem #1 (1)
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In Economics, we always assume rationality
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For example, you will pay $3500 for a new mobile phone
because you think the new mobile phone is worth at least $3500
or the new phone will potentially bring you happiness or
enjoyment that is worth at least $3500
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The first line says the most you would be willing to pay for a car
wash is $6
 $6 is actually your benefit of having a washed car
 You pay $6 for a car wash because you think the service is worth
$6; you wont pay $6 for a type of service that you think is only
worth $5
Solution to problem #1 (2)
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The question also says the smallest amount for
which you would be willing to wash a car for
someone is $3.5
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$3.5 is actually your cost for performing a car wash for
someone else
$3.5 is just right at compensating for the value of your effort
and time spent on the car wash
You would be happy if someone pays you more than $3.5
for a car wash; however, you would not be willing to
perform a car wash if someone pays you less than $3.5 as
the price does not cover the value of your alternate activity
such as an afternoon tea or an afternoon nap
Solution to problem #1 (3)
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Cost-benefit principle
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An action should be taken, if and only if, the extra benefits
from taking the action are at least as great as the extra
costs
Benefit of performing a car wash = $6
Cost of performing a car wash = $3.5
Net benefit (economic surplus) is the difference
between benefit and cost
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NB= B-C
Economic surplus = $6- $3.5 = $2.5
Problem #3, Chapter 1
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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.
Solution to problem #3 (1)
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Initially the city has imposed a lump-sum fee of $6 per week
for garbage collection
 No garbage = $6
 1 can of garbage = $6
 2 cans of garbage =$6…
 Extra cost of an additional can of garbage =$0
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Now the city imposes a pay-as-you-go fee for garbage
collection called “tag system.”
 No garbage =$0
 1 can of garbage =$2
 2 cans of garbage =$4…
 Extra cost of an additional tag (can of garbage) =$2
Solution to problem #3 (2)
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The initial plan is more
favourable to residents
who have so much
garbage
The current plan is
more favourable to
residents who have
less garbage
Initial plan
(lump-sum)
Current Plan
(Pay-as-you-go)
2 cans = $6
2 cans = $4
3 cans = $6
3 cans = $6
4 cans = $6
4 cans = $8
5 cans = $6
5 cans = $10
6 cans = $6
6 cans = $12
Solution to problem #3 (3)
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Suppose now the pay-as-you-go plan is effective,
residents who discharge less garbage are favoured
All residents are now induced to reducing their
garbage so as to avoid the marginal cost of disposal
of $2 for which it was initially zero
The total quantity of garbage collected will
decrease
The new garbage disposal system functions well in
reducing amount of garbage which in turn produces
a positive impact on the environment
Problem #5, Chapter 1
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Tom is a mushroom farmer. He invests all his spare
cash in additional mushrooms, which grow on
otherwise useless land behind his barn. The
mushrooms double in weight during their first year,
after which time they are harvested and sold at a
constant price per pound. Tom’s friend Dick asks
Tom for a loan of $200, which he promises to repay
after 1 year. How much interest will Dick have to pay
Tom in order for Tom to recover his opportunity cost
of making the loan? Explain briefly.
Solution to problem #5 (1)
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This problem is very similar to Example 1.13
that Dr. Wong covered in class last week
Suppose Tom now has some spare money
available to lend to Dick
But such lending generates an opportunity
cost
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By lending Dick the money, Tom scarifies the right
of using the money to invest in growing
mushrooms
Solution to problem #5 (2)
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If Tom does not lend the money to Dick, Tom
can invest $200 in growing mushrooms which
in turn will earn a 100% return, as the
mushrooms double in weight in one year
By investing $200 in mushrooms, Tom can
potentially come out with a return of $200
after a year
Thus, Dick should pay Tom an interest at
least $200 after a year
Solution to problem #5 (3)
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An interest of $200 is just enough to compensate for Tom’s loss
of investment opportunity in mushrooms
If Dick pays Tom an interest of $200, Tom is indifferent between
investing in mushrooms and lending the money to Dick, as the
payoff ($200) is the same for both options
What if Dick pays Tom an interest more than $200? Tom will gain
more by lending the money to Dick
What if Dick pays Tom an interest less than $200? Tom will loss
by lending the money to Dick as a better option actually available.
If Tom lends money to Dick at an interest less than $200, say
$100, Tom is sending Dick a gift equivalent to $100 (=200-100).
Problem #7, Chapter 1
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Martha and Sarah have the same preferences and
incomes. Just as Martha arrived at the theater to
see a play, she discovered that she had lost the $10
ticket she had purchased earlier. Sarah just arrived
at the theater planning to buy a ticket to see the
same play when she discovered that she had lost a
$10 bill from her wallet. If both Martha and Sarah
are rational and both still have enough money to pay
for a ticket, is one of them likely than the other to go
ahead and see the play anyway?
Solution to problem #7 (1)
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Martha and Sarah should make the same move
They both share some similarities
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An identical preference refers to an identical benefit
from watching the movie
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Same preference
Same income
Same sunk cost
Enjoy the movie at a same level
Get the same level of benefit from watching the movie
Equal income
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Face the same income/ financial constraint
Both have enough money to buy a movie ticket
Solution to problem #7 (2)
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Same sunk cost
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“Costs that have already been incurred and which cannot
be recovered to any significant degree.” – Dr. Wong, Glossary of
Economic Terms
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For Martha
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The money ($10) that paid for the lost ticket is a sunk cost
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Incurred and unrecoverable- does not affect her decision about
buying another ticket
For Sarah
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The $10 bill lost is a sunk cost
 Incurred and unrecoverable- does not affect her decision
about buying a ticket
Solution to problem #7 (3)
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In fact, sunk costs should never be included in the
decision making process
Given that both Martha and Sarah face the same
ticket price, same financial constraint and same
benefit from watching the movie, they should go
ahead with the movie if:
Benefit from watching the movie > Cost of watching movie
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See- Cost-benefit analysis applied to all questions
involve Economics
Problem #9, Chapter 1
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For each long-distance call anywhere in the
continental United States, a new phone
service will charge users 30 cents per minute
for the first 2 minutes and 2 cents per minute
for additional minutes in each call. Tom’s
current phone service charges 10 cents per
minute for all calls, and his calls are never
shorter than 7 minutes. If Tom’s dorm
switches to the new phone service, what will
happen to the average length of his calls?
Solution to problem #9 (1)
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At a length of seven minutes, both service plans
charge exactly the same amount - $0.70 for seven
minutes
If Tom talks beyond 7 minutes,
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Under the current service plan, the marginal cost is $0.10
per minute
Under the new service plan, the marginal cost is only $0.02
per minute
Since Tom never talks on phone shorter than seven
minutes, he will be benefited from a new lower
marginal cost under the new service plan
Solution to problem #9 (2)
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Suppose the new service plan is now
effective.
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Will Tom change his behaviour?
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A lower marginal cost will encourage Tom to
talk longer under the new phone service plan.
Done!!!
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If you have any questions or concerns with
exercise, you are always welcomed to come
to my office KKL 1109 during my office hours
posted on the course website
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Or reach me through email:
[email protected]
The end
Thanks for coming!
See you next week!