Chapter 2: Economists’ View of Behavior
MARGINAL ANALYSIS
Discussion Question Answers:
The marginal (incremental) benefit of this transaction is the $600 of increased revenue. You need
to calculate your marginal (incremental) costs to decide if you should accept or reject the
proposed deal. The monthly lease and insurance expenses are not incremental, but sunk (you pay
them whether you take the deal or not). You expect that the trucker will use the 100 gallons of
fuel. The fuel can be replaced for $3.25 per gallon for a total cost of $325. The retail price of
$4.00 per gallon is irrelevant since the transaction does not affect the amount of fuel that you can
sell to your other customers. You have to pay $.50 to the lease company for every mile that the
customer drives the truck. The customer will pay this cost once he reaches 500 miles. You are
CONSUMER CHOICE AND GRAPHICAL TOOLS
Discussion Question Answers:
A potential economic explanation for the differences in wine consumption in the two countries is
that one country has a higher tax rate on wine than the other. Holding income and preferences
Other Goods
Wine
Budget line for a representative consumer in the low-wine-tax country
Budget line for a representative consumer in the high-wine-tax country
Whigh tax Wlow tax
Prior to collecting any “real world” data your economic explanation is simply a plausible theory.
Before you take any action you should consider whether there is any data that you could use to
help confirm the validity of your explanation. For example, at a minimum you would want to
determine whether the tax rates are actually different in the two countries. It might also be useful
to examine data across a larger sample of countries to help confirm that there is a negative
relation between tax rates and wine consumption across countries. Other possible data and
analysis could be useful. You should also consider whether there are any other plausible
1. Now suppose that you have determined that the likely cause is the difference in tax rates, there
are at least two actions that you might take to increase wine sales in the country with the higher
tax rate. First, you might bottle the wine in larger bottles. The tax is on a per bottle basis and
thus the customer pays a lower tax per unit of volume when the wine is sold in large bottles. This
Indifference curves derived from a common utility function that
is assumed to be the same for the representative consumers from
both countries (note that the consumer in the low-tax country is
able to obtain higher utility because they face an effectively
lower price for wine)
2. A preferences-based explanation for the differences in consumption between the two countries
would focus on potential differences in tastes and preferences between the citizens of the two
countries. For example, one country might be populated by people who have strong cultural or
religious conditioning against consuming alcohol, while people from the other country are
known to “enjoy a bottle of wine with every dinner.” Changing people’s preferences can be
difficult and so it is often useful to look at potential economic explanations first (since a manager
typically has more control over changing constraints than preferences). Also it is often difficult to
INTERWEST HEALTHCARE CORP
Discussion Question Answers:
This case is based on an actual business. The real CEO subscribed to the “good citizen model.”
He reasoned that the hospital administrators did not understand the importance of accurate
information reporting to the company. He had several meetings and retreats with the relevant
employees. He encouraged accurate reporting, stressed its importance, and motivated
face-to-face meetings between hospital and corporate personnel. None of these actions had the
To motivate increased concern about the information system among hospital administrators, the
RISK AVERSION VERSUS RISK TAKING
Discussion Question Answers:
It is generally difficult to change a person’s preferences toward risk. A short experience in
gambling is unlikely to do so. The training program might identify individuals with risk
tolerances Trilogy desires. However, the people are already hired and this is unlikely to be the
