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Section 6: Economics and Decision Making
Question 1
1. Jackie owns and operates a website design business. To keep up with new technology, she
spends $5,000 per year upgrading her computer equipment. She runs the business out of a
room in her home. If she didn’t use the room as her business office, she could rent it out for
$2,000 per year. Jackie knows that if she didn’t run her own business, she could return to her
previous job at a large software company that would pay her a salary of $60,000 per year.
Jackie has no other expenses.
a. How much total revenue does Jackie need to make in order to break even in the eyes of her
accountant? That is, how much total revenue would give Jackie an accounting profit of
just zero?
b. How much total revenue does Jackie need to make in order for her to want to remain self-
employed? That is, how much total revenue would give Jackie an economic profit of just
zero?
Solution 1
Question 2
2. You own and operate a bike store. Each year, you receive revenue of $200,000 from your
bike sales, and it costs you $100,000 to obtain the bikes. In addition, you pay $20,000 for
electricity, taxes, and other expenses per year. Instead of running the bike store, you could
become an accountant and receive a yearly salary of $40,000. A large clothing retail chain
wants to expand and offers to rent the store from you for $50,000 per year. How do you
explain to your friends that despite making a profit, it is too costly for you to continue
running your store?
Solution 2
2. Your yearly accounting profit is:
Question 3
3. Suppose you have just paid a nonrefundable fee of $1,000 for your meal plan for this
academic term. This allows you to eat dinner in the cafeteria every evening.
a. You are offered a part-time job in a restaurant where you can eat for free each evening.
Your parents say that you should eat dinner in the cafeteria anyway, since you have
already paid for those meals. Are your parents right? Explain why or why not.
b. You are offered a part-time job in a different restaurant where, rather than being able to eat
for free, you receive only a large discount on your meals. Each meal there will cost you
$2; if you eat there each evening this semester, it will add up to $200. Your roommate says
that you should eat in the restaurant since it costs less than the $1,000 that you paid for the
meal plan. Is your roommate right? Explain why or why not.
Solution 3
Question 4
4. You have bought a $10 ticket in advance for the college soccer game, a ticket that cannot be
resold. You know that going to the soccer game will give you a benefit equal to $20. After
you have bought the ticket, you hear that there will be a professional baseball post-season
game at the same time. Tickets to the baseball game cost $20, and you know that going to the
baseball game will give you a benefit equal to $35. You tell your friends the following: “If I
had known about the baseball game before buying the ticket to the soccer game, I would have
gone to the baseball game instead. But now that I already have the ticket to the soccer game,
it’s better for me to just go to the soccer game.” Are you making the correct decision? Justify
your answer by calculating the benefits and costs of your decision.
Solution 4
4. Yes, you are making the correct decision. If you had known about the baseball game before
buying the ticket to the soccer game, your decision would have been as follows:
Question 5
5. Amy, Bill, and Carla all mow lawns for money. Each of them operates a different lawn
mower. The accompanying table shows the total cost to Amy, Bill, and Carla of mowing
lawns.
Quantity
of lawns
mowed
Amy’s total
cost
Bill’s total
cost
Carla’s total
cost
0
$0
$0
$0
1
20
10
2
2
35
20
7
3
45
30
17
4
50
40
32
5
52
50
52
6
53
60
82
a. Calculate Amy’s, Bill’s, and Carla’s marginal costs, and draw each of their marginal cost
curves.
b. Who has increasing marginal cost, who has decreasing marginal cost, and who has constant
marginal cost?
Solution 5
5. a. The accompanying table shows Amy’s, Bill’s, and Carla’s marginal costs.
Question 6
6. You are the manager of a gym, and you have to decide how many customers to admit each
hour. Assume that each customer stays exactly one hour. Customers are costly to admit
because they inflict wear and tear on the exercise equipment. Moreover, each additional
customer generates more wear and tear than the customer before. As a result, the gym faces
increasing marginal cost. The accompanying table shows the marginal costs associated with
each number of customers per hour.
a. Suppose that each customer pays $15.25 for a one-hour workout. Use the profit-
maximizing principle of marginal analysis to find the optimal number of customers that
you should admit per hour.
b. You increase the price of a one-hour workout to $16.25. What is the optimal number of
customers per hour that you should admit now?
Solution 6
Question 7
7. LaNisha and Lauren are economics students who go to a karate class together. Both have to
choose how many classes to go to per week. Each class costs $20. The accompanying table
shows LaNisha and Lauren’s estimates of the marginal benefit that each of them gets from
each class per week.
a. Use marginal analysis to find Lauren’s optimal number of karate classes per week. Explain
your answer.
b. Use marginal analysis to find LaNisha’s optimal number of karate classes per week.
Explain your answer.
Solution 7
Question 8
8. The Centers for Disease Control and Prevention (CDC) recommended against vaccinating the
whole population against the smallpox virus because the vaccination has undesirable, and
sometimes fatal, side effects. Suppose the accompanying table gives the data that are
available about the effects of a smallpox vaccination program.
Percent of
population
vaccinated
Deaths due to
smallpox
Deaths due to
vaccination side
effects
0%
200
0
10
180
4
20
160
10
30
140
18
40
120
33
50
100
50
60
80
74
a. Calculate the marginal benefit (in terms of lives saved) and the marginal cost (in terms of
lives lost) of each 10% increment of smallpox vaccination. Calculate the net increase in
human lives for each 10% increment in population vaccinated.
b. Using marginal analysis, determine the optimal percentage of the population that should be
vaccinated.
Solution 8
Question 9
9. Patty delivers pizza using her own car, and she is paid according to the number of pizzas she
delivers. The accompanying table shows Patty’s total benefit and total cost when she works a
specific number of hours.
Quantity of
hours worked
Total benefit
Total cost
0
$0
$0
1
30
10
2
55
21
3
75
34
4
90
50
5
100
70
a. Use marginal analysis to determine Patty’s optimal number of hours worked.
b. Calculate the total profit to Patty from working 0 hours, 1 hour, 2 hours, and so on. Now
suppose Patty chooses to work for 1 hour. Compare her total profit from working for 1 hour
with her total profit from working the optimal number of hours. How much would she lose
by working for only 1 hour?
Solution 9
Question 10
10. Assume De Beers is the sole producer of diamonds. When it wants to sell more diamonds, it
must lower its price in order to induce shoppers to buy more. Furthermore, each additional
diamond that is produced costs more than the previous one due to the difficulty of mining for
diamonds. De Beers’s total benefit schedule is given in the accompanying table, along with
its total cost schedule.
Quantity of
diamonds
Total benefit
Total cost
0
$0
$0
1
1,000
50
2
1,900
100
3
2,700
200
4
3,400
400
5
4,000
800
6
4,500
1,500
7
4,900
2,500
8
5,200
3,800
a. Draw the marginal cost curve and the marginal benefit curve and, from your diagram,
graphically derive the optimal quantity of diamonds to produce.
b. Calculate the total profit to De Beers from producing each quantity of diamonds. Which
quantity gives De Beers the highest total profit?
Solution 10
Question 11
11. In each of the following examples, explain whether the decision is rational or irrational.
Describe the type of behavior exhibited.
a. Kookie’s best friend likes to give her gift cards that Kookie can use at her favorite stores.
Kookie, however, often forgets to use the cards before their expiration date or loses them.
Kookie, though, is careful with her own cash.
b. The Panera Bread company opened a store in Clayton, Missouri, that allowed customers to
pay any amount they like for their orders; instead of prices, the store listed suggested
donations based on the cost of the goods. All profits went to a charitable foundation set up
by Panera. A year later, the store was pleased with the success of the program.
c. Rick has just gotten his teaching degree and has two job offers. One job, replacing a teacher
who has gone on leave, will last only two years. It is at a prestigious high school, and he
will be paid $35,000 per year. He thinks he will probably be able to find another good job
in the area after the two years are up but isn’t sure. The other job, also at a high school,
pays $25,000 per year and is virtually guaranteed for five years; after those five years, he
will be evaluated for a permanent teaching position at the school. About 75% of the
teachers who start at the school are hired for permanent positions. Rick takes the five-year
position at $25,000 per year.
d. Kimora has planned a trip to Florida during spring break in March. She has several school
projects due after her return. Rather than do them in February, she figures she can take her
books with her to Florida and complete her projects there.
e. Sahir overpaid when buying a used car that has turned out to be a lemon. He could sell it for
parts, but instead he lets it sit in his garage and deteriorate.
f. Barry considers himself an excellent investor in stocks. He selects new stocks by finding
ones with characteristics similar to those of his previous winning stocks. He chalks up
losing trades to ups and downs in the macroeconomy.
Solution 11
Question 12
12. You have been hired as a consultant by a company to develop the company’s retirement plan,
taking into account different types of predictably irrational behavior commonly displayed by
employees. State at least two types of irrational behavior employees might display with
regard to the retirement plan and the steps you would take to forestall such behavior.
Solution 12
Question 13
13. For each of the following situations, decide whether Al has diminishing marginal utility.
Explain.
a. The more economics classes Al takes, the more he enjoys the subject. And the more classes
he takes, the easier each one gets, making him enjoy each additional class even more than
the one before.
b. Al likes loud music. In fact, according to him, “the louder, the better.” Each time he turns
the volume up a notch, he adds 5 utils to his total utility.
c. Al enjoys watching reruns of the X Files. He claims that these episodes are always exciting,
but he does admit that the more times he sees an episode, the less exciting it gets.
d. Al loves toasted marshmallows. The more he eats, however, the fuller he gets and the less
he enjoys each additional marshmallow. And there is a point at which he becomes satiated:
beyond that point, more marshmallows actually make him feel worse rather than better.
Solution 13
Question 14
14. Use the concept of marginal utility to explain the following: Newspaper vending machines
are designed so that once you have paid for one paper, you could take more than one paper at
a time. But soda vending machines, once you have paid for one soda, dispense only one soda
at a time.
Solution 14
