Economics 1st Edition Acemoglu Test Bank 1

Microeconomics (Acemoglu/Laibson/List)
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Chapter 3 Optimization: Doing the Best You Can
3.1 Two Kinds of Optimization: A Matter of Focus
1) Making choices by selecting the best feasible option, given the available information is referred to as:
A) delegation.
B) imposition.
C) actualization.
D) optimization.
Answer: D
Difficulty: Easy
Topic: Two Kinds of Optimization: A Matter of Focus
2) Which of the following statements is true?

A) It is easier for a person to optimize when he has less information.
B) Optimization implies choosing the best option from a set of alternatives.
C) People always successfully optimize given the limited information they have.
D) Optimization is an easy process, and all economic agents are perfect optimizers.
Answer: B
Difficulty: Easy
3) Optimization can be achieved using either of two techniques of cost benefit analysis. Which of the
following correctly identifies the techniques?
A) Optimization in levels and optimization in programs
B) Optimization in levels and optimization in differences
C) Optimization in programs and optimization in frames
D) Optimization in differences and optimization in frames
Answer: B
Difficulty: Easy
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4) Optimization in levels calculates:
A) the total net benefits of different alternatives.
B) only the benefits of an alternative and not the costs.
C) only the costs of an alternative and not the benefits.
D) the change in net benefits when you shift from one alternative to another.
Answer: A
Difficulty: Easy
2
5) John has to choose between a camping holiday and a holiday in Las Vegas. If he evaluates the total net
benefit of both alternatives before coming to a decision, he is using the technique of:
A) marginal analysis.
B) ordinal analysis.
C) optimization in levels.
D) optimization in differences.
Answer: C
Difficulty: Easy
AACSB: Application of Knowledge
6) Which of the following is NOT a step involved in optimization in levels?

A) Calculating the total net benefit of each alternative
B) Choosing the alternative with the highest net benefit
C) Converting all costs and benefits into a common value of measurement
D) Calculating the marginal consequences of moving between alternatives
Answer: D
Difficulty: Medium
7) Optimization in differences analyzes:

A) the total net benefits of different alternatives.
B) only the costs of an alternative and not the benefits.
C) the total net benefits of the alternative which looks the most attractive.
D) the change in the net benefits when you shift from one alternative to another.
Answer: D
Difficulty: Easy
8) Gary has to decide between attending a two-day art workshop and a four-day art workshop. If he
evaluates only the change in net benefit when he switches between the two options, he is using the
technique of:
A) ordinal analysis.
B) comparative statics.
C) optimization in levels.
D) optimization in differences.
Answer: D
Difficulty: Easy
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9) The techniques of optimization in levels and optimization in differences:
A) cannot be used to compare the same set of alternatives.
B) compare only the costs and ignores the benefits of the alternatives.
C) provide identical answers when comparing the same set of alternatives.
D) may provide different answers when comparing the same set of alternatives.
Answer: C
Difficulty: Easy
10) Which of the following statements identifies a difference between optimization in levels and
optimization in differences?
A) Optimization in levels compares only the costs of different alternatives, whereas optimization in
differences compares only the benefits of different alternatives.
B) Optimization in levels compares only the benefits from different alternatives, whereas optimization in
differences compares only the costs of different alternatives.
C) Optimization in levels calculates the net benefits of different alternatives, whereas optimization in
differences calculates the change in net benefits when switching from one alternative to another.
D) Optimization in levels calculates the change in net benefits when switching from one alternative to
another, whereas optimization in differences calculates the net benefits of different alternatives.
Answer: C
Difficulty: Easy
11) Which of the following statements identifies a difference between optimization in levels and
A) In most cases, optimization in levels is faster and easier than optimization in differences.
B) In many cases, optimization in differences is faster and easier than optimization in levels.
C) Optimization in differences compares only the cost involved in different alternatives, whereas
optimization in levels compares the net benefit of different alternatives.
D) Optimization in differences compares the net benefit of different alternatives, whereas optimization in
levels compares only the cost involved in different alternatives.
Answer: B
Difficulty: Easy
12) Both optimization in levels and optimization in differences:

A) consider only the benefits from different alternatives.
B) consider only the costs incurred in different alternatives.
C) provide identical answers when comparing two alternatives.
D) require the calculation of change in net benefits of switching from one alternative to another.
Answer: C
Difficulty: Easy
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13) Which of the following statements identifies a similarity between optimization in levels and
A) Both techniques consider only the costs of different alternatives.
B) Both techniques consider only the total benefits of different alternatives.
C) Both techniques evaluate the total net benefit of different alternatives to arrive at a decision.
D) Both techniques require the conversion of all costs and benefits into a common unit of measurement.
Answer: D
Difficulty: Easy

A) Marginal analysis is a key component in the process of optimization in levels.
B) Only direct costs are considered when the net benefits of the alternatives are calculated.
C) In both the techniques of optimization, all costs have to be converted to the same unit of measurement.
D) Optimization in levels calculates the change in net benefits when a person switches from one
alternative to another.
Answer: C
Difficulty: Easy
15) To calculate the ________ of an alternative, an individual needs to estimate ________ of the
alternative.
A) marginal benefit; total cost
B) marginal cost; total benefit
C) opportunity cost; total benefit
D) net benefit; both cost and benefit
Answer: D
Difficulty: Medium
16) Net benefits of an alternative equal:

A) benefits minus costs.
B) benefits divided by costs.
C) the sum of benefits and costs.
D) the product of benefits and costs.
Answer: A
Difficulty: Easy
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17) If an alternative provides a benefit of $8 to an individual at a cost of $6, the net benefits of the
alternative equal:
A) $0.75.
B) $2.
C) $14.
D) $48.
Answer: B
Difficulty: Medium
18) When optimizing in levels, if the ________ exceeds the ________, project A is chosen over project B.
A) net benefits of project A; net benefits of project B
B) total benefits of project A; total benefits of project B
C) marginal cost of project A; marginal costs of project B
D) marginal benefits of project B; marginal benefits of project A
Answer: A
Difficulty: Medium
19) If the ________ minus the ________ is positive, project A is chosen over project B.
A) cost of project A; cost of project B
B) net benefit of project B; net benefit of project A
C) net benefit of project A; net benefit of project B
D) total benefit of project B; total benefit of project A
Answer: C
Difficulty: Medium
20) If the net benefit of Project A is $5 and that of project B is $8, switching from project A to project B:
A) reduces the net benefit by $3.
B) increases the net benefit by $3.
C) increases the net benefit by $8.
D) decreases the net benefit by $8.
Answer: B
Difficulty: Medium
21) If the net benefit of project A is $20 and that of project B is $15, switching from project A to project B:
A) reduces the net benefit by $5.
B) increases the net benefit by $5.
C) reduces the net benefit by $15.
D) increases the net benefit by $15.
Answer: A
Difficulty: Medium
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22) If the net benefit of project A is $10 and that of project B is $12, which of the following statements is
true?
A) An individual can optimize by choosing Project A.
B) An individual can optimize by choosing Project B.
C) Switching from project A to project B reduces the net benefit by $2.
D) Switching from project A to project B increases the net benefit by $1.2.
Answer: B
Difficulty: Medium
23) If project A has a cost of $5, and a provides a benefit of $10, and project B has a cost of $2, and
provides benefit of $4, then switching from project A to project B:
A) increases the net benefit by $3.
B) decreases the net benefit by $3.
C) increases the net benefit by $6.
D) decreases the net benefit by $6.
Answer: B
Difficulty: Medium
24) If project A has a cost of $2, and provides a benefit of $3, and project B has a cost of $ 5 and provides a
benefit of $8, which of the following statements is true?
A) The net benefit of project A is $5.
B) An individual can optimize by choosing Project B.
C) Project A has a higher net benefit than project B.
D) A shift from project A to project B increases the net benefit by $1.
Answer: B
Difficulty: Medium
25) If project X has a cost of $6 and provides a benefit of $10, and project Y has a cost of $25 and provides
a benefit of $27, which of the following statements is true?
A) An individual can optimize by choosing project X.
B) An individual can optimize by choosing project Y.
C) Switching from project X to project Y increases net benefit by $2.
D) Switching from project Y to project X decreases net benefit by $2.
Answer: A
Difficulty: Medium
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26) In most cases, optimization in differences is faster and easier than optimization in levels because:
A) the former involves lesser number of steps to arrive at a conclusion.
B) the former uses simpler arithmetic tools in comparison to the latter.
C) the former only focuses on the benefits of an option ignoring all calculations involving costs.
D) the former only focusses on the key differences between options and ignores things in common.
Answer: D
Difficulty: Easy
27) What is meant by the term "optimization"? What do economists usually believe about how
individuals optimize?
Answer: Choosing the best option from a set of feasible alternatives is referred to as optimization.
Whatever choice a person faces, economists believe that he or she is likely to try to choose optimally.
Economists don't assume that people always successfully choose the best feasible option, but that people
try to do so and usually do a good job with whatever, potentially limited information they have. This
doesn't mean that people are always perfect calculators. Instead, economists believe that people's
behavior is only approximated by optimization. In other words, they believe that an agent's actual choice
will sometimes differ from that person's optimal choice.
Difficulty: Easy
28) What are the two techniques to optimization? How do the techniques differ?
Answer: Optimization can be achieved using either of two techniques: optimization in levels or
optimization in differences. Although both techniques provide identical results, there are differences
between them. Optimization in levels analyzes the total net benefit of different alternatives, whereas
optimization in differences analyzes the change in net benefits when switching from one alternative to
another. Optimization in differences is often faster to implement than optimization in levels, since
optimization in differences only focuses on the way alternatives differ.
Difficulty: Medium
29) What are the steps involved in optimization in levels? If option A has a cost of $5 and provides a
benefit of $8, and option B has a cost of $10 and provides a benefit of $15, which of the two projects is
optimal?
Answer: The steps involved in optimization in levels are:
a) Translate all costs and benefits into common units, like dollars.
b) Calculate the total net benefit of each alternative.
c) Pick the alternative with the highest net benefit.
Total net benefit in option A = $(8 - 5) = $3
Total net benefit in option B = $(15 - 10) = $5
Since option B has a higher net benefit than option A, option B is the optimal choice of the two.
Difficulty: Medium
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30) Assume that an individual has to choose between two options: buying a mobile phone, or buying an
MP3 player. The expected cost of buying a phone is $700 and the expected benefit is $900. The expected
cost of buying an MP3 player is $300, and the expected benefit is $600. How does the individual arrive at
the optimal choice if he implements
a) optimization in levels?
b) optimization in differences?
Answer:
a) The process of optimization in levels will require the comparison of net benefit of both the available
options. This is shown as follows:
Net benefit of buying a phone = $900 - $700 = $200.
Net benefit of buying an MP3 player = $600 - $300 = $300.
Since net benefit of an MP3 player exceeds the net benefit of a mobile phone, optimization in levels will
suggest buying an MP3 player.
b) The process of optimization in differences will require the estimation of the change in net benefit
when an individual shifts from one alternative to another. This is shown as follows:
Change in net benefit if the individual chooses to buy an MP3 player over a mobile phone = $300 - $200 =
$100, which is positive. On the other hand, change in net benefit if the individual chooses to buy a phone
over an MP3 player = $200 - $300 = -$100, which is negative. Hence, optimization in differences will
suggest buying an MP3 player.
Difficulty: Medium
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31) How does optimization in levels differ from optimization in differences? Assume that the city council
has to choose one among the following three alternatives: setting up a school, setting up a hospital, and
setting up a playground. The estimates of expected cost and benefit of all three projects are shown in the
following table. How does the city council arrive at the optimal choice if both the techniques of
optimization are implemented? Do the results vary?
Project Cost ($) Benefit ($)

Playground 15,000 30,000
School 20,000 50,000
Hospital 50,000 75,000
Answer: The basic difference between the two techniques is that optimization in levels estimates the total
net benefits of different alternatives before arriving at the optimum decision, whereas optimization in
differences estimates the change in net benefits when the decision maker shifts from one alternative to
another.
Net benefit of setting up a school = $50,000 - $20,000 = $30,000
Net benefit of setting up a hospital = $75,000 - $50,000 = $25,000
Net benefit of setting up a playground = $30,000 - $15,000 = $15,000
Optimization in levels compares the net benefit of all alternatives before arriving at an optimum. The net
benefit of setting up a school is the highest among all three alternatives, hence it is the optimum decision
when optimizing in levels.
Optimization in differences compares the change in net benefit when switching from an alternative to
another.
If the city council chooses to set up a school over setting up a playground,
change in net benefit = $30,000 - $15,000 = $15,000
If the city council chooses to build a hospital over setting up a playground,
change in net benefit = $25,000 - $15,000 = $10,000.
Therefore, setting up a playground is not the optimum choice.
Instead of building a hospital, if a school is built, change in net benefit = $30,000 - $25,000 = $5,000.
Since the change in net benefit when switching from hospital to school is positive, setting up a school is a
better option among the two. Hence, setting up a school is the optimum decision among the three
alternatives when optimizing in differences.
Therefore, we can see that both the techniques suggest that building a school is the optimum choice.
Difficulty: Medium
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3.2 Optimization in Levels
1) To carry out an optimization analysis:

A) different types of costs are measured in different units.
B) only direct costs incurred in a project are to be estimated.
C) only indirect costs incurred in a project are to be estimated.
D) all costs are required to be converted to a same unit of measurement.
Answer: D
Difficulty: Easy
Topic: Optimization in Levels
2) If the opportunity cost of time is $20 per hour, and an individual spends 20 hours in commuting every
month, his opportunity cost of commute is:
A) $1 per month.
B) $20 per month.
C) $200 per month.
D) $400 per month.
Answer: D
Difficulty: Medium
3) If the opportunity cost of time is ________, and an individual spends ________ commuting every
month, his opportunity cost of commute is $100 every month.
A) $5 per hour; 10 hours
B) $8 per hour; 20 hours
C) 10 per hour; 10 hours
D) $12 per hour; 5 hours
Answer: C
Difficulty: Medium
4) If an individual's opportunity cost of commute is $300 per month and his monthly commuting time is
60 hours, his opportunity cost of time is:
A) $5 per hour.
B) $10 per hour.
C) $30 per hour.
D) $60 per hour.
Answer: A
Difficulty: Medium
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5) Among a set of alternatives with the same benefits, an individual is said to optimize if she chooses an
alternative that:
A) has the lowest total cost.
B) has the highest total cost.
C) has the highest indirect cost.
D) has the lowest opportunity cost.
Answer: A
Difficulty: Medium
6) Among a set of alternatives with the same total costs, an individual is said to optimize if she chooses an
alternative that has the:
A) highest total benefit.
B) highest risk.
C) lowest opportunity costs.
D) highest net costs.
Answer: A
Difficulty: Easy
7) An individual pays $100 every month as rent for an apartment, and his monthly opportunity cost of
commuting from the apartment to his place of work is $40. Which of the following statements is then
true?
A) The direct cost of renting the apartment is $140.
B) The indirect cost of renting the apartment is $140.
C) The direct cost of renting the apartment is $40, whereas the indirect cost of renting the apartment is
$100.
D) The direct cost of renting the apartment is $100, whereas the indirect cost of renting the apartment is
$40.
Answer: D
Difficulty: Medium
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Ryan wants to rent an apartment. The following table shows the monthly rent of five apartments and the
monthly commuting time to work from each apartment. Ryan's opportunity cost of time is $15 per hour.
Commuting Time
Apartment (hours/month) Rent ($/month)
1 40 1,500
2 20 1,750
3 10 2,000
4 4 2,210
5 1 2,250
8) Refer to the table above. What is the total cost incurred per month if Ryan rents apartment 3?
A) $2,000
B) $2,050
C) $2,150
D) $2,270
Answer: C
Difficulty: Medium
9) Refer to the table above. What is the total cost incurred per month if Ryan rents apartment 5?
A) $2,150
B) $2,270
C) $2,400
D) $2,265
Answer: D
Difficulty: Medium
10) Refer to the table above. What is the opportunity cost of commute per month to work if Ryan rents
apartment 2?
A) $20
B) $150
C) $200
D) $300
Answer: D
Difficulty: Medium
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11) Refer to the table above. The total cost per month is the highest if Apartment ________ is rented.
A) 2
B) 3
C) 4
D) 5
Answer: C
Difficulty: Medium
12) Refer to the table above. The total cost per month is the lowest if Ryan chooses to rent Apartment
________.
A) 1
B) 2
C) 3
D) 4
Answer: B
Difficulty: Medium
13) Refer to the table above. If the opportunity cost of time increases to $60 per hour, renting which
apartment will minimize Ryan's total cost every month?
A) 2
B) 3
C) 4
D) 5
Answer: D
Difficulty: Medium
Topic: Comparative Statics
14) Refer to the table above. If the opportunity cost of time increases to $60 per hour, renting which
apartment will turn out to be the most expensive every month?
A) 1
B) 2
C) 3
D) 4
Answer: A
Difficulty: Medium
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15) The analysis of economic outcomes before and after some economic variable is changed is referred to
as:
A) Pareto analysis.
B) marginal study.
C) cardinal research.
D) comparative statics.
Answer: D
Difficulty: Easy

A) Marginal analysis is a key tool used while optimizing in levels.
B) Comparative statics is a tool that can be used in both optimization in levels and optimization in
differences.
C) Marginal analysis is the comparison of economic outcomes before and after some economic variable is
changed.
D) Comparative statics involves calculating the incremental cost of moving from one alternative to the
next best alternative.
Answer: B
Difficulty: Medium
17) The analysis of how a customer's tastes for cars will change when his wealth triples is under the scope
of:
A) ordinal study.
B) marginal research.
C) Pareto analysis.
D) comparative statics.
Answer: D
Difficulty: Easy
18) Which of the following is an example of comparative statics?

A) The estimation of the quantity demanded of a good when its price is $5.
B) The estimation of the demand for a particular good when consumer income is $10.
C) The estimation of the ideal number of workers a firm should hire, when wage rate is $20 per hour.
D) The estimation of the supply of a good when the wage rate of labor changes from $30 to $10 per hour.
Answer: D
Difficulty: Medium
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19) An individual rents an apartment for $200 per month. His monthly opportunity cost of commuting to
work from this apartment is $50. After a year, he moves to an apartment closer to his place of work, but
pays $250 as rent. Compared to the initial situation, after a year:
A) his direct cost of renting the apartment increases, while the indirect cost of renting the apartment
remains unchanged.
B) his direct cost of renting the apartment increases, while the indirect cost of renting the apartment
decreases.
C) his direct cost of renting the apartment remains the same, while the indirect cost of renting the
apartment decreases.
D) his direct cost of renting the apartment remains the same, while the indirect cost of renting the
apartment increases.
Answer: B
Difficulty: Medium
The following graph shows an individual's total cost of renting four apartments located at different
distances from her place of work.
20) Refer to the figure above. Which apartment is the best feasible choice for the individual?
A) Apartment 1
B) Apartment 2
C) Apartment 3
D) Apartment 4
Answer: C
Difficulty: Easy
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21) Refer to the figure above. Other things remaining the same, assume that the individual now has a
higher opportunity cost of time. Which of the following statements is true in this context?
A) The cost curve will move up.
B) The cost curve will move down.
C) Optimization in levels will not lead to an efficient outcome.
D) Optimization in differences will not lead to an efficient outcome.
Answer: A
Difficulty: Medium
22) An individual decides to rent an apartment for $7,000 every month. The commuting time from this
apartment to his office is 80 hours per month. If the individual's opportunity cost of time is $30 per hour,
calculate the direct cost, indirect cost, and total cost per month she would incur if she rents the apartment.
Answer: The direct cost of renting the apartment equals the monthly rent of the apartment. So, direct
costs equal $7,000 every month.
The indirect cost of renting the apartment is equal to the commuting time expressed in dollar terms.
Since, the individual will spend 80 hours in commuting every month, and the opportunity cost of one lost
hour is $30, his indirect costs equal $30 × 80 = $2,400 per month.
The individual's total cost equals the sum of direct cost and indirect cost. Therefore, total cost is equal to
$7,000 + $2,400 = $9,400 every month.
Difficulty: Medium
23) Refer to the table below. Given that an individual's opportunity cost of time is $30 per hour, which of
the two apartments should she rent?
Monthly Commuting Time

Apartment (Hours) Monthly Rent ($)
1 60 3,600
2 20 4,500
Answer: Answer: The opportunity cost of commuting per month from apartment 1 = 60 × $30 = $1,800.
Total monthly cost of renting apartment 1 = $1,800 + $3,600 = $5,400.
The opportunity cost of commuting per month from apartment 2 = 20 × $30 = $600
Total monthly cost of renting apartment 2 = $600 + $4,500 = $5,100
Therefore, the individual chooses Apartment 2 as she incurs a lower cost if she rents Apartment 2 than
when she rents Apartment 1.
Difficulty: Medium
17
24) Assume that an individual with an opportunity cost of time of $20 per hour has to choose between
renting four apartments. The rents of the four apartments and the individual's monthly commuting time
to work are shown in the following table. Calculate the direct cost, indirect cost, and total cost, that the
individual will incur if she rents any of these apartments. Also, determine the apartment which is
optimum for the individual. Graph the total cost involved for the various choices.

Apartment (hours) Rent ($)
1 60 2,800
2 90 2,200
3 120 1,500
4 150 1,400
Answer: Direct cost of renting apartment 1 = $2,800

Indirect cost of renting apartment 1 = 60 × $20 = $1,200
Total cost of renting apartment 1 = $2,800 + $1200 = $4,000
Direct cost of renting apartment 2 = $2,200

Total cost of renting apartment 2 = $2,200 + $1,800 = $4,000

Total cost involved in renting apartment 3 = $1,500 + $2,400 = $3,900

Total cost involved in renting apartment 4 = $1,400 + $3,000 = $4,400
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From the above estimations, it is seen that the total cost is least if the individual rents apartment 3. Hence,
renting apartment 3 is optimum for the individual.
Difficulty: Medium
19
25) What is meant by comparative statics? Assume that a firm wants to set up a factory. It considers four
different locations. The rent of the factory space and the time taken to transport the products from each of
the locations to the market is shown in the table below. It is also given that the opportunity cost of time is
$10 per hour.
a) Which is the optimum location?
b) If the opportunity cost of time changes to $30 per hour, is there any change in the optimum?
Time taken to transport the

products to the market
Location (hours per month) Rent ($ per month)
1 180 3,000
2 150 3,200
3 100 3,600
4 60 4,100
Answer: Comparative statics is the comparison of economic outcomes before and after some economic
variable is changed. For example, a consumer might want to purchase a bigger apartment when his
wealth increases. Here, the apartment choice is the economic variable which changes when wealth
increases.
a) When the opportunity cost of time is $10 per hour, the cost calculations are shown below.
The opportunity cost of transporting the products to the market per month from location 1 = 180 × $10 =
$1,800.
Total cost of building the factory in location 1 = $3,000 + $1,800 = $4,800.
$1,500.
$1,000.
$600.
Total cost of building the factory in location 4 = $4,100 + $600 = $4,700.
From the above calculations it is seen that when the opportunity cost of time is $10 per hour, the factory
should be optimally located in location 3.
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b) When the opportunity cost of time increases to $30 per hour, there will be a change in the total cost of
building the factory in each location. The new costs are calculated as follows.
$5,400.
Total cost of building the factory in location 1 = $3,000 + $5,400 = $8, 400.
$4,500.
$3,000.
$1,800.
From the above calculations it is seen that when the opportunity cost of time increases from $10 per hour
to $30 per hour, the optimum location of the factory changes from location 3 to location 4.
Difficulty: Hard
3.3 Optimization in Differences: Marginal Analysis

A) Optimization in levels is based on ordinal analysis.
B) Optimization in differences is based on marginal analysis.
C) Optimization in differences is often faster than optimization in levels as it considers all aspects of the
feasible alternatives.
D) Optimization in levels is often slower to implement than optimization in differences as it considers
only the aspects in which alternatives differ.
Answer: B
Difficulty: Easy
Topic: Optimization in Differences: Marginal Analysis
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2) Assume that an individual has to decide between a two-day vacation and a three-day vacation to the
same place. If he uses optimization in differences, he will:
A) only think about the net benefits of the extra day.
B) compare the total net benefits of both alternatives.
C) choose the three-day vacation only if the costs incurred on the third day exceed the benefits he
receives.
D) spend more time to come to a decision than if he would have used optimization in levels.
Answer: A
Difficulty: Medium
Scenario: Sarah has to choose between renting a hotel room for two days and renting a hotel room for
three days.
3) Refer to the scenario above. Which of the following statements is true?

A) Both optimization techniques will provide an efficient outcome, but optimization in levels will be
faster to implement.
B) Both optimization techniques will provide an efficient outcome, but optimization in differences will be
C) Only optimization in differences can be used to arrive at an optimum choice. Optimization in levels
will not be applicable in this case.
D) Only optimization in levels can be used to arrive at an optimum choice. Optimization in differences
will not be applicable in this case.
Answer: B
Difficulty: Easy
4) Refer to the scenario above. If Sarah is optimizing in differences, then which of the following
statements is true?
A) An optimizer will rent the hotel room for three days, if the benefit of staying for the third day exceeds
the cost of staying for the third day.
B) An optimizer will rent the hotel room for three days, if the benefit of staying for the third day exceeds
the benefits of staying for the first two days.
C) An optimizer will rent the hotel room for three days, if the net benefit of staying for three days exceeds
the net benefit of staying for two days.
D) An optimizer will rent the hotel room for three days, if the cost of staying for the first two days is less
than the cost of staying for the third day.
Answer: A
Difficulty: Medium
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5) Refer to the scenario above. Which of the following is true, if the individual is optimizing in levels?
A) An optimizer will rent the hotel room for three days, if the net benefit of staying for the third day is
negative.
B) An optimizer will rent the hotel for three days, if the cost of staying for two days exceeds the cost of
staying for three days.
C) An optimizer will rent the hotel room for three days, if the net benefit of staying for three days exceeds
the net benefit of staying for two days.
D) An optimizer will rent the hotel for three days, if the total benefit of staying for three days exceeds the
total benefits of staying for two days.
Answer: C
Difficulty: Medium
6) A cost-benefit calculation that focuses on the difference between a feasible alternative and the next
feasible alternative is called:
A) marginal analysis.
B) cardinal analysis.
C) Pareto analysis.
D) ordinal analysis.
Answer: A
Difficulty: Easy
7) Which of the following is an example of marginal analysis?

A) To determine the optimal number of workers, a firm calculates the net benefits of hiring an extra
worker.
B) To determine the optimal amount of fertilizer to be used, a farmer calculates the total benefits of using
a given amount of fertilizer.
C) To choose the optimal apartment to rent, an individual estimates the net benefits of renting an
apartment close to his/her place of work.
D) To determine the optimal output that a firm should sell, the manager calculates the total revenue
earned by selling different levels of output.
Answer: A
Difficulty: Medium
8) Which of the following statements is true of marginal analysis?

A) Marginal analysis is a tool used in optimization in levels.
B) Marginal analysis compares the consequences of doing one more step of something.
C) Marginal analysis of alternatives will mostly give an outcome different from optimization in levels.
D) Marginal analysis involves the calculation of total net benefits of all the available alternatives.
Answer: B
Difficulty: Medium
23
9) ________ uses the concept of marginal analysis to determine the optimum choice.
A) Ordinal analysis
B) Optimization in levels
C) Optimization in frames
D) Optimization in differences
Answer: D
Difficulty: Easy
10) ________ is the incremental cost generated by moving from one feasible alternative to the next feasible
alternative.
A) Total cost
B) Indirect cost
C) Marginal cost
D) Average cost
Answer: C
Difficulty: Easy
Topic: Marginal Cost
11) If the total cost incurred in hiring ten workers by a firm is $45, and the total cost incurred when the
eleventh worker is hired is $60, the marginal cost of hiring the eleventh worker is:
A) $1.33.
B) $15.
C) $20.
D) $105.
Answer: B
Difficulty: Medium
12) In choosing between apartments in two different locations, the marginal commuting cost is given by:
A) the sum of the commuting cost from each apartment to the destination.
B) the commuting cost from the apartment located closer to the destination.
C) the commuting cost from the apartment located farther away from the destination.
D) the difference between the commuting cost from two different apartments to the destination.
Answer: D
Difficulty: Easy
24
13) If the marginal rent cost of moving from apartment 1 to apartment 2 is -$60 and marginal commuting
cost of moving from apartment 1 to apartment 2 is $40:
A) moving from apartment 1 to 2 will cost the renter $60 more in rent and $40 more in commuting.
B) moving from apartment 1 to 2 will save the renter $60 more in rent and $40 more in commuting.
C) moving from apartment 1 to 2 will save the renter $60 in rent but cost $40 more in commuting.
D) moving from apartment 1 to 2 will cost the renter $60 more in rent but save $40 in commuting.
Answer: C
Difficulty: Medium
Assume that a firm wants to set up a factory. It has four different options. The rent of the factory in the
four different locations and the time taken to transport the product from each location to the market is
shown in the following below. The opportunity cost of time is $10 per hour.

Factory Location (hours) Monthly Rent ($)
Very far 30 2,060
Far 25 2,100
Close 15 2,300
Very Close 5 2,500
14) Refer to the table above. If the firm decides to choose factory "Far" over "Close," what is its marginal
opportunity cost of transporting products to the market?
A) $100
B) -$200
C) $50
D) $150
Answer: A
Difficulty: Medium
15) Refer to the table above. What is the marginal rent cost if the firm decides to choose factory "Very
Close" over factory "Close"?
A) -$100
B) -$200
C) $100
D) $200
Answer: D
Difficulty: Medium
25
16) Refer to the table above. What is the marginal opportunity cost of transporting products to the market
if the firm decides to choose factory "Far" over factory "Very Far"?
A) -$50
B) -$100
C) $50
D) $150
Answer: A
Difficulty: Medium
17) Refer to the table above. What is the marginal rent cost if the firm decides to choose factory "Far" over
factory "Very Far"?
A) $40
B) $100
C) $150
D) -$150
Answer: A
Difficulty: Medium
18) Refer to the table above. For which of the following choices is the marginal total cost the lowest?
A) Choosing factory "Close" over factory "Far"
B) Choosing factory "Far" over factory "Very Far"
C) Choosing factory "Very Close" over factory "Close"
D) Choosing factory "Close" over factory "Very Far"
Answer: B
Difficulty: Medium
19) Refer to the table above. Which is the optimum location for the firm to set up its factory?
A) Far
B) Very far
C) Close
D) Very Close
Answer: A
Difficulty: Medium
26
20) The principal of optimization at the margin states that:
A) an optimal alternative has the least indirect costs in comparison to other feasible alternatives.
B) an optimal alternative has the highest net benefits in comparison to other feasible alternatives.
C) moving toward the optimal alternative makes the decision maker better off, and moving away from it
makes him worse off.
D) moving toward the optimal alternative makes the decision maker worse off, and moving away from it,
makes the decision maker better off.
Answer: C
Difficulty: Medium
Assume that there are five apartments located at different distances from an individual's place of work:
very close, close, far, very far, and extremely far. The individual makes his choice by studying the change
in costs as he moves farther from his place of work. An individual has to choose between renting one of
the five apartments. The movement from apartment "very close" to "close" has a marginal cost of -$60, a
movement from apartment "close" to "far" has a marginal cost of -$40, a movement from apartment "far"
to "very far" has a marginal cost of -$10, and a movement from apartment "very far" to "extremely far" has
a marginal cost of $20.
21) Refer to the scenario above. Which of the following shifts will increase the total cost?
A) Shift from apartment "close" to "far"
B) Shift from apartment "far" to "very far"
C) Shift from apartment "very close" to "close"
D) Shift from apartment "very far" to "extremely far"
Answer: D
Difficulty: Medium
22) Refer to the scenario above. Which of the following is the optimum choice?
A) Apartment "very close"
B) Apartment "close"
C) Apartment "far"
D) Apartment "very far"
Answer: D
Difficulty: Medium
27
23) Refer to the scenario above. Which of the following techniques is used to arrive at the optimum
decision in the scenario?
A) Optimization in levels
B) Comparative statics
C) Total net benefit approach
D) Principal of Optimization at the Margin
Answer: D
Difficulty: Medium
24) Total cost falls when marginal cost is ________, and total cost rises when marginal cost is ________.
A) zero; negative
B) zero; positive
C) positive; negative
D) negative; positive
Answer: D
Difficulty: Medium

A) Optimizers with the highest opportunity cost of time push up the rental price of apartments with the
highest commute time.
B) Optimizers with the lowest opportunity cost of time push up the rental price of apartments with the
lowest commute time.
C) As the rental prices of downtown apartments rise, only workers with the highest opportunity cost of
time will be willing to rent them.
D) As the rental prices of downtown apartments rise, only workers with the lowest opportunity cost of
time will be willing to rent them.
Answer: C
Difficulty: Easy
Topic: Evidence-Based Economics: How Does Location Affect the Rental Cost of Housing?
26) In a marketplace, the rental price of apartments is determined by:

A) negotiations between renters and regulators.
B) negotiations between renters and landlords.
C) negotiations between landlords and regulators.
D) negotiations between politicians and regulators.
Answer: B
Difficulty: Easy
28
27) In a marketplace, prices:
A) are determined through auctions.
B) are determined by politicians and regulators.
C) act as incentives which allow for the efficient allocation of resources.
D) act as a measure of value, and do not affect the allocation of resources.
Answer: C
Difficulty: Easy
28) Spending more time commuting in exchange for a lower monthly rent refers to a(n):
A) barter.
B) trade-off.
C) externality.
D) monetary exchange.
Answer: B
Difficulty: Easy
29) What is meant by comparative statics? Is it different from the concept of marginal analysis? Explain
with the help of suitable examples.
Answer: Comparative statics is the comparison of economic outcomes before and after some economic
variable is changed. For example, an individual may choose an apartment A which is far from his place of
work over apartment B which is closer. However, if his opportunity cost of time increases, the total cost
of renting apartment A also increases, and his optimal choice might change.
Marginal analysis, on the other hand, is a completely different concept. It is a cost-benefit calculation that
studies the differences between feasible alternatives. For example, if a firm which has 10 employees wants
to hire an 11th employee, it will not consider the net benefit of the 10 employees who are already
employed. Instead the firm will focus only on estimating the net benefit of hiring the eleventh employee
to arrive at a decision.
Difficulty: Medium
30) What are the different steps involved in optimization in differences?

Answer: Optimization in differences has three steps:
a) Translate all costs and benefits into common units, like dollars.
b) Calculate the marginal consequences of moving between alternatives.
c) Apply the Principal of Optimization at the Margin by choosing the alternative with the property that
moving to it makes you better off and moving away from it makes you worse off.
Difficulty: Easy
29
31) Mary has to choose between a four-day vacation and a five-day vacation to the same place. To arrive
at the optimal choice which optimization technique do you think will be arithmetically easier and faster
to implement and why?
Answer: In this case, to arrive at the optimal choice, optimization in differences will be arithmetically
easier to implement than optimization in levels. If she optimizes in levels, she would evaluate the total
net benefit of a four-day trip and compare it to the total net benefit of a five-day trip. On the other hand,
optimization in differences will only require an estimation of the net benefit of the fifth day, as the first
four days are common in both options. This makes it easier and faster to implement.
Difficulty: Medium
32) What is the Principal of Optimization at the Margin? Explain with an example.
Answer: The Principal of Optimization at the Margin states that an optimal alternative has the property
that moving to it makes the decision maker better off and moving away from it makes the decision maker
worse off. For example, if an individual has to choose between alternative apartments, she will choose the
apartment moving towards which lowers her total cost, and moving away from which increases her total
cost. Such an apartment will be an optimal choice according to the Principal of Optimization at the
Margin.
Difficulty: Easy
33) If the marginal total cost when moving from option A to option B is negative and the marginal total
cost when moving from option B to A is positive, which of the two options is better? What is the
underlying principal behind the decision?
Answer: A negative marginal total cost implies that the decision-maker is gaining from the switch
between options. A positive marginal cost implies that the decision-maker is losing from the switch
between options. In this case, moving to option B makes the decision maker better off while moving away
from it makes the decision maker worse off. Hence, option B is better of the two. The underlying
principal behind this decision is referred to as the Principal of Optimization at the Margin.
Difficulty: Medium
30
34) From the table below, choose the optimum option using marginal analysis.
Option Total Cost ($)

1 150
2 100
3 80
4 70
5 90
6 120
Answer: To arrive at an optimum decision using marginal analysis, marginal total costs are to be
estimated. This is done in the following table.
Marginal total cost

Option Total Cost ($) ($)
1 150 -
2 100 -50
3 80 -20
4 70 -10
5 90 20
6 120 30
Option 4 is the optimum option in this case. This is because it is the only option which moving towards
makes the decision maker better off and moving away from it makes the decision maker worse off. In
other words, according to the Principal of Optimization at the Margin, option 4 is the optimum choice.
Difficulty: Medium
35) Does optimization at the margin have any advantage over optimization in levels? Explain with the
help of a suitable example.
Answer: Optimization at the margin is less time consuming and simpler as the decision maker can ignore
everything about different alternatives that are being compared except the particular attributes that are
different. For example, if two apartments are located adjacent to each other, and the only difference
between them is the rent, optimization in levels would require the calculation of net benefits of each
apartment by considering all costs and benefits. On the other hand, since marginal analysis only
considers the differences between the two, all attributes which are common in the two apartments can be
ignored and the decision maker can focus only on the attributes which are different, in this case only the
rent.
Difficulty: Medium
31
36) How do markets provide for an efficient allocation of scarce resources?
Answer: The market prices of the various products, as determined by the market forces, provide
incentives that implicitly allocate economic resources. The market allows the optimizing buyers and
sellers to freely negotiate the prices of various goods and services. For example, in the market for
apartments, optimizing landlords and optimizing renters can freely negotiate the rental price of an
apartment. These market prices then provide incentives which allow for efficient allocation of scarce
resources. This allocation mechanism implies, for example, that mostly highly paid workers—and others
with a high opportunity cost of time—tend to rent the apartments with the best locations.
Difficulty: Medium
37) Shirley has to choose between a two-day trip and a three-day trip to Hollywood. The table below
shows the expected benefit and cost for the different days. Using optimization in levels and optimization
in differences, determine what Shirley's optimum decision should be. Does the decision differ with the
techniques used? Which technique is faster to implement?
Day Cost Benefit

1 $750 $800
2 $900 $1,000
3 $600 $800
Answer:
Optimization in levels
Optimization in levels requires a comparison of the net benefit of the two-day trip and net benefit of the
three-day trip.
Net benefit of the two-day trip: $(800 - 750) + $(1000 - 900) = $50 + $100 = $150.
Net benefit of the three-day trip: $(800 - 750) + $(1000 - 900) + $(800 - 600) = $50 + $100 + $200 = $350.
Since the net benefit of a three-day trip is higher than the net benefit of a two-day trip, Shirley should
choose a three-day trip.
Optimization in differences
Optimization in differences will require the decision to be made only on the basis of the net benefit of the
third day.
Net benefit of the third day = $800 - $600 = $200, which is positive. Hence, optimization in differences also
suggests that Shirley should take the three-day trip.
Both methods to optimization will always give identical results, although optimization in differences is
Difficulty: Medium
32
38) What is meant by the term "marginal analysis"? Suppose, an individual has to choose between renting
four apartments at different distances from his place of work. The individual has to commute to work on
five days of the week and as such will require different quantities of gasoline depending on the
apartment he decides to rent. The monthly rents and expected gasoline consumption from each of the
apartments is shown in the table below. If the price of gasoline is known at $5 per gallon, using marginal
analysis, determine the optimum choice for the individual. Which principal is used for this optimization?
What does it state?
Gasoline consumption
Apartment (gallons per month) Rent ($ per month)
1 5 1,100
2 10 1,000
3 15 960
4 20 940
Answer: Marginal analysis is a cost-benefit analysis that compares the consequences of doing one step
more of something. Hence, it is a cost-benefit calculation that studies the difference between a feasible
alternative and the next feasible alternative.
To arrive at the conclusion regarding optimum choice of apartment using marginal analysis, it is essential
to calculate the marginal commuting cost and the marginal rent cost for movement between each set of
alternatives. This is shown in the table below.
Gasoline Marginal Marginal Marginal

consumption Commuting Commuting Rent ($ Rent Cost Total Cost
(gallons per cost ($ per Cost ($ per per ($ per ($ per
Apartment month) month) month) month) month) month)
1 5 25 - 1,100 - -
2 10 50 25 1,000 -100 -75
3 15 75 25 960 -40 -15
4 20 100 25 940 -20 5
The marginal total cost of moving from apartment 1 to apartment 2 is -$75. This implies that the
individual gains $75 if he moves from apartment 1 to apartment 2. This move is beneficial.
The second movement—from apartment 2 to apartment 3—has a marginal total cost of -$15. This implies
that the individual gains $15, if he moves from apartment 2 to apartment 3. This move is beneficial too.
The third move—from apartment 3 to apartment 4—has a marginal total cost of $5. This implies that the
individual loses $5, if he moves from apartment 3 to apartment 4. This move is not beneficial.
Hence, from the above inferences it is clear that moving towards apartment 3 is beneficial, whereas
moving away from apartment 3 is not. This implies apartment 3 is the optimum choice for the individual.
The principle used to arrive at the optimum choice is referred to as the Principal of Optimization at the
Margin. It states that an optimal alternative has the property that moving to it makes the decision-maker
better off and moving away from it makes the decision-maker worse off.
Difficulty: Hard
33
39) Kevin is a student who is yet to join a university in California. In the evening, he takes music lessons.
Kevin has to decide on an apartment to rent. The apartment should be at a suitable distance from two
places: his university, and from his music classes. The commuting time from apartments in four different
locations to both destinations are shown in the table below. Given that Kevin's opportunity cost of time is
$10 per hour, find his optimum choice using:
a) optimization in levels.
b) optimization in differences.
Commuting time to Commuting time to

university (hours per music classes
Apartment month) (hours per month) Rent ($ per month)
1 10 10 2,500
2 16 24 2,200
3 36 24 1,900
4 45 35 1,800
Answer:
a) To optimize in levels, it is required to calculate the total cost of renting all apartments. This is shown
in the table below.
Commuting Total
time to Commuting Total opportunity
university time to music commuting cost of Rent per Total Cost
(hours per classes (hours time (hours commute per month per month
Apartment month) per month) per month) month ($) ($) ($)
1 10 10 20 200 2,500 2,700
2 16 24 40 400 2,200 2,600
3 36 24 60 600 1,900 2,500
4 45 35 80 800 1,800 2,600
From the table above, it is seen that the total cost will be least for Kevin if he chooses to rent apartment 3.
Hence, optimizing in levels suggests that apartment 3 is the optimum choice for Kevin.
34
b) To optimize in differences, it is required to calculate the marginal total cost of switching between
each consecutive set of alternatives. This is shown in the table below.
Total Marginal
Total opportunity opportunity Marginal
commuting cost of cost of Rent per Marginal total cost
time (hours commute per commute per month rent per ($ per
Apartment per month) month ($) month ($) ($) month ($) month)
1 20 200 - 2,500 0 -
2 40 400 200 2,200 -300 -100
3 60 600 200 1,900 -300 -100
4 80 800 200 1,800 -100 100
From the above table it is seen that Kevin is better off when he moves towards apartment 3 and is worse
off when he moves away from apartment 3. Hence, according to the Principal of Optimization at the
Margin it can be concluded that apartment 3 is the optimum choice for Kevin.
Difficulty: Hard
35

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Chapter 3 Optimization: Doing the Best You Can

3.1 Two Kinds of Optimization: A Matter of Focus

2) Which of the following statements is true?

6) Which of the following is NOT a step involved in optimization in levels?

7) Optimization in differences analyzes:

12) Both optimization in levels and optimization in differences:

14) Which of the following statements is true?

16) Net benefits of an alternative equal:

Project Cost ($) Benefit ($)

Net benefit of setting up a school = $50,000 - $20,000 = $30,000

Net benefit of setting up a hospital = $75,000 - $50,000 = $25,000

Net benefit of setting up a playground = $30,000 - $15,000 = $15,000

1) To carry out an optimization analysis:

16) Which of the following statements is true?

18) Which of the following is an example of comparative statics?

Monthly Commuting Time

Monthly Commuting Time

Answer: Direct cost of renting apartment 1 = $2,800

Direct cost of renting apartment 2 = $2,200

Direct cost of renting apartment 3 = $1,500

Direct cost of renting apartment 4 = $1,400

Time taken to transport the

3.3 Optimization in Differences: Marginal Analysis

1) Which of the following statements is true?

3) Refer to the scenario above. Which of the following statements is true?

7) Which of the following is an example of marginal analysis?

8) Which of the following statements is true of marginal analysis?

Monthly Commuting Time

25) Which of the following statements is true?

26) In a marketplace, the rental price of apartments is determined by:

30) What are the different steps involved in optimization in differences?

Option Total Cost ($)

Marginal total cost

Day Cost Benefit

Gasoline Marginal Marginal Marginal

Commuting time to Commuting time to

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