Economics in Modules 3rd Edition

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 section 7

Economics and
Decision Making
1. Hiro owns and operates a small business that provides economic consulting ser-
vices. During the year he spends $57,000 on travel to clients and other expenses. In
addition, he owns a computer that he uses for business. If he didn’t use the com-
puter, he could sell it and earn yearly interest of $100 on the money created through
this sale. Hiro’s total revenue for the year is $100,000. Instead of working as a con-
sultant for the year, he could teach economics at a small local college and make a
salary of $50,000.
a. What is Hiro’s accounting profit?
b. What is Hiro’s economic profit?
c. Should Hiro continue working as a consultant, or should he teach economics
instead?

Solution
1. a. Hiro’s accounting profit is:
$100,000 (total revenue)
− $57,000 (travel and other expenses)
$43,000 (accounting profit)
b. Hiro’s economic profit is:
$43,000 (accounting profit)
− $100 (interest forgone)
− $50,000 (salary as economics professor)
− $7,100 (economic profit)
c. Since Hiro’s economic profit is negative, he would be better off if he didn’t
operate the consulting business and taught economics instead.

2. Jackie owns and operates a web-design business. To keep up with new technol-
ogy, 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 compa-
ny 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?
S-69

KrugEcon3eModsPS_Sec07.indd S-69 10/21/13 11:49 AM

 S-70 SECTION 7 ECONOMICS AND DECISION MAKING

Solution
2. a. Jackie’s accounting profit is: Total revenue − $5,000. (The only cost that her
accountant would add into the accounting profit calculation is the cost of
upgrading her computer equipment.) For her accounting profit to be just equal
to zero, her total revenue would have to be $5,000.
b. Jackie’s economic profit is: Total revenue − $5,000 − $2,000 − $60,000 = Total
revenue − $67,000. (Cost of equipment upgrade, the opportunity cost of not
renting out the room, and the opportunity cost of Jackie’s time are all costs that
figure into the calculation of economic profit.) For this to be just equal to zero,
Jackie’s total revenue would have to be $67,000.

3. 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 run-
ning 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
3. Your yearly accounting profit is:
$200,000 (total revenue)
− $100,000 (cost of bikes)
− $20,000 (electricity, taxes, and other expenses)
$80,000 (accounting profit)
But not renting the store to the retail chain is an opportunity cost, and not being
able to make $40,000 as an accountant is also an opportunity cost, so your yearly
economic profit is:
$80,000 (accounting profit)
− $40,000 (opportunity cost of your time)
− $50,000 (opportunity cost of not renting the store)
− $10,000 (economic profit)
So although you make an accounting profit each year, you would be better off
renting the store to the large chain and becoming an accountant yourself, since
your opportunity cost of continuing to run your own store is too high.

4. 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.

KrugEcon3eModsPS_Sec07.indd S-70 10/21/13 11:49 AM

 ECONOMICS AND DECISION MAKING SECTION 7 S-71

Solution
4. a. Your parents are wrong. They are making the mistake of considering sunk
costs. Since the $1,000 that you have already paid for the meal plan is nonre-
fundable, it should not enter into your decision making now. Your decision of
where to eat should depend only on those costs and benefits that are affected
by your decision. Since both the cafeteria meals and the restaurant meals are
free, you should choose to eat where the benefit to you (convenience, quality of
food, and so on) is greater.
b. Your roommate is wrong. Since the $1,000 that you have already paid for the
meal plan is nonrefundable, it should not enter into your decision making now.
It is a sunk cost. In deciding where to eat, you should weigh the benefit and
cost of eating in the restaurant (where each meal costs $2) against the benefit
and cost of eating in the cafeteria (where meals are free). You may decide to eat
in the restaurant, but only if that gives you a benefit that is at least $2 greater
than the benefit you get from eating in the cafeteria.

5. 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 pro-
fessional 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 base-
ball 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 deci-
sion? Justify your answer by calculating the benefits and costs of your decision.

Solution
5. 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:
Go to the soccer game Go to the baseball game
$20 (benefit) $35 (benefit)
−$10 (cost of ticket) −$20 (cost of ticket)
$10 $15

Since the baseball game would have given you the greater total profit, you should
have gone to the baseball game. But after you have already bought the ticket to
the soccer game, your decision is different: the ticket to the soccer game (since
it cannot be resold) is now a sunk cost, and you should no longer take it into
account. Your decision now looks as follows:
Go to the soccer game Go to the baseball game
$20 (benefit) $35 (benefit)
−$20 (cost of ticket)
$20 $15

So, since you had already bought the ticket to the soccer game before you heard
about the baseball game, it is optimal for you to go to the soccer game.

KrugEcon3eModsPS_Sec07.indd S-71 10/21/13 11:49 AM

 S-72 SECTION 7 ECONOMICS AND DECISION MAKING

6. 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 Amy’s Bill’s Carla’s

lawns mowed total cost total cost 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 mar-
ginal cost curves.
b. Who has increasing marginal cost, who has decreasing marginal cost, and who
has constant marginal cost?

Solution
6. a. The accompanying table shows Amy’s, Bill’s, and Carla’s marginal costs.

Amy’s Bill’s Carla’s

Quantity marginal marginal marginal
of lawns Amy’s cost of Bill’s cost of Carla’s cost of
mowed total cost lawn mowed total cost lawn mowed total cost lawn mowed

0 $0 $0 $0
$20 $10 $2
1 20 10 2
15 10 5
2 35 20 7
10 10 10
3 45 30 17
5 10 15
4 50 40 32
2 10 20
5 52 50 52
1 10 30
6 53 60 82

The accompanying diagram shows Amy’s, Bill’s, and Carla’s marginal cost
curves.

Marginal
cost of
lawn mowed

$30
Amy’s Carla’s
MC MC

20 Bill’s
MC

10

0 1 2 3 4 5 6
Quantity of lawns mowed

KrugEcon3eModsPS_Sec07.indd S-72 10/21/13 11:49 AM

 ECONOMICS AND DECISION MAKING SECTION 7 S-73

b. From the information in the table or from the diagram, you can see that Amy
has decreasing marginal cost, Bill has constant marginal cost, and Carla has
increasing marginal cost. (Also note that all of them have increasing total cost.)

7. 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 cus-
tomer before. As a result, the gym faces increasing marginal cost. The accompany-
ing table shows the marginal costs associated with each number of customers per
hour.

Quantity of Marginal cost

customers per hour of customer

0
$14.00
1
$14.50
2
$15.00
3
$15.50
4
$16.00
5
$16.50
6
$17.00
7

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
7. a. The marginal benefit of each customer is $15.25: each additional customer
you admit increases the total benefit to the gym by $15.25. So you should
admit three customers per hour. Here is how you could think about that
decision. Suppose you currently admit no customers. Admitting the first
customer gives the gym a marginal benefit of $15.25 and a marginal cost of
$14.00. Since the marginal benefit of that first customer exceeds the marginal
cost, you want to admit the first customer. For the second customer, the mar-
ginal benefit ($15.25) also exceeds the marginal cost ($14.50), so you want to
admit the second customer, too. The same is true for the third customer: the
marginal benefit ($15.25) exceeds the marginal cost ($15.00), so you also want
to admit the third customer. For the fourth customer, however, the marginal
cost ($15.50) exceeds the marginal benefit ($15.25), so you do not want to
admit a fourth customer.
b. By reasoning similar to that in part a, you now want to admit five customers:
for the fifth customer, the marginal benefit ($16.25) exceeds the marginal cost
($16.00). For the sixth customer, however, the marginal cost ($16.50) exceeds
the marginal benefit, so you do not want to admit a sixth customer.

KrugEcon3eModsPS_Sec07.indd S-73 10/21/13 11:49 AM

 S-74 SECTION 7 ECONOMICS AND DECISION MAKING

8. Georgia 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 Georgia’s and Lauren’s estimates of the marginal
benefit that each of them gets from each class per week.

Lauren’s Georgia’s
Quantity of marginal benefit marginal benefit
classes of each class of each class

0
$23 $28
1
$19 22
2
$14 15
3
$08 7
4

a. Use marginal analysis to find Lauren’s optimal number of karate classes per
week. Explain your answer.
b. Use marginal analysis to find Georgia’s optimal number of karate classes per
week. Explain your answer.

Solution
8. The marginal cost of one more class is always $20: each additional class that
Lauren or Georgia takes will cost an additional $20.
a. The optimal number of classes per week for Lauren is one. The marginal ben-
efit to Lauren of the first class is $23, and the marginal cost is $20. Since the
marginal benefit exceeds the marginal cost, Lauren wants to take that first
class. For the second class, Lauren’s marginal benefit ($19) is less than the mar-
ginal cost ($20), so she does not want to take a second class.
b. Georgia would be better off adding a second class per week. For the second
class, the marginal benefit to Georgia ($22) exceeds the marginal cost ($20), so
she wants to take the second class. For the third class, the marginal cost ($20)
would exceed the marginal benefit ($15), so Georgia does not want to take the
third class. For Georgia, the optimal number of classes per week is two.

9. The Centers for Disease Control and Prevention (CDC) recommended against vac-
cinating 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 Deaths due to Deaths due to

vaccinated smallpox 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.

KrugEcon3eModsPS_Sec07.indd S-74 10/21/13 11:49 AM

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Archpriest’s hand, and girdeth himself. And the Archpriest saith,
Axios. And they sing in the altar and without in like manner. And they
do the same with the phelonion, and with the sloujébnik. And the
Archpriest saith with each, Axios. And they sing according to custom.
And, having kissed the omophorion and the Archpriest’s hand, he
that hath received the laying on of hands as priest goeth out and
kisseth the archimandrites, and all the co-ministrants on the
shoulder, and standeth with the priests.

THE ORDER OF THE OFFICE FOR THE MAKING

OF A PROTOPRESBYTER.
He that is to be appointed protopresbyter is conducted by a
protodeacon, or by two deacons, to the right reverend Archpriest in
the middle of the church, where the Archpriest standeth at the time
of the introit with the gospel. And he inclineth himself to his girdle
before the Archpriest thrice, and boweth his head. And the
Archpriest, sitting, signeth him with the hand on his head crosswise
thrice. And, rising, he layeth his hand upon his head. And the
protodeacon having said, Let us pray to the Lord,
the Archpriest saith this prayer.
Master, Lord Jesus Christ, our God, who hast bestowed priesthood
on our race, and hast endued us with the grace of this gift and
honour, and hast appointed us who are sufficiently pious to rule the
priestly order, and the other subordinate ministers of thy mysteries;
do thou thyself endue our brother, name, with thy grace, and adorn
him with virtue to stand at the head of the presbyters of thy people,
and make him worthy to be a good example to them that are with
him; and be thou pleased that he may finish his life in piety and
virtue unto a good old age; and, as the good God, have mercy upon
us all. For thou art the giver of wisdom, and all creation singeth thee
to ages of ages.
Then the Archpriest signeth his head crosswise, saying, Blessed
be the Lord, lo, the servant of God, name, becometh protopresbyter
of the most holy church of God, name, in the name of the Father,
and of the Son, and of the Holy Ghost.
And the Archpriest, laying his hand upon his head, exclaimeth,
Axios, iii. And the singers sing, Axios, thrice. Then they range the
protopresbyter with the other clergy according to rite, and they go
into the altar through the royal doors, and they act with the ministers
according to rite.

THE OFFICE THAT IS USED AT THE

APPOINTMENT OF AN ABBOT.
He that is to be appointed abbot is conducted by a protodeacon, or
by two deacons, to the Archpriest in the middle of the church, where
the Archpriest standeth at the time of the introit with the gospel, if the
Archpriest himself be celebrating the liturgy. But if not, they bring to
the Archpriest the epitrachelion, the maniples, and the omophorion,
and he vesteth himself, standing in his place. And he that is to be
appointed abbot is conducted to his place, and inclineth himself to
his girdle before the Archpriest thrice, and boweth his head. And the
Archpriest, sitting, signeth him with the hand upon his head thrice.
And, rising, he layeth his hand upon his head, and the protodeacon
having said, Let us pray to the Lord,
the Archpriest saith this prayer.
O God, who ever makest provision for the salvation of men, and
gatherest together in one this thy rational flock; do thou, O Master of
all things, in thy measureless love to man, thyself preserve this same
blameless, keeping thy commandments continually, so that not one
sheep thereof may be lost, and be devoured by the wolf. And declare
this thy servant, whom thou art pleased to appoint abbot over it,
worthy of thy grace, and adorn him with all virtues, that he, by his
works, may be a good example to them that are under him, that they,
being emulators of his blameless conversation, may stand with him
uncondemned before thy fearful judgment-seat.
 Exclamation. For thine is the kingdom, and the power, and the
glory, of the Father, and of the Son, and of the Holy Ghost, now and
ever, and to ages of ages. Singers. Amen.
Archpriest. Peace to all.
Singers. And to thy spirit. Protodeacon. Bow your heads to the
Lord. Singers. To thee, O Lord.
The Archpriest prayeth secretly.
Incline thine ear, O Lord, and hearken unto our prayer, and declare
this thy servant to be abbot of this honourable habitation, a faithful
and wise administrator over the rational flock committed to him by
thy grace, he doing thy will in all things, and becoming worthy of thy
heavenly kingdom.
Exclamation.
Through the grace, and compassions, and love to man of thine
only-begotten Son, with whom thou art blessed, together with thine
all-holy, and good, and life-creating Spirit, now and ever, and to ages
of ages. Amen.
And the protodeacon saith with a loud voice, Bid, master.
And the Archpriest saith with a loud voice,
The grace of the all-holy Spirit, through our mediocrity, appointeth
thee abbot of the honourable habitation of our Lord, God, and
Saviour, Jesus Christ, name, whatever title of him the temple may
be, or, of our most holy God-bearing Lady, whatever title of her the
temple may be, or, of Saint, name, to whom may be dedicated the
temple.
Then, laying his hand upon his head, the Archpriest exclaimeth,
Axios, thrice. And the singers sing, Axios, thrice.
After this he that hath been appointed abbot
kisseth the Archpriest’s omophorion on the right
and left shoulder; and, being conducted, he rangeth
himself with the other abbots according to rite; and
they go into the altar through the royal
 doors, and he acteth with the
ministers according
to rite.

THE OFFICE THAT IS USED AT THE

APPOINTMENT OF AN ARCHIMANDRITE.
He that is to be appointed archimandrite is conducted by a
protodeacon, or by two deacons, to the Archpriest in the middle of
the church where the Archpriest standeth at the time of the introit
with the gospel, if the Archpriest himself be celebrating the liturgy.
But if not, they bring the epitrachelion, the maniples, and the
omophorion to the Archpriest, and he vesteth himself standing in his
place. And he that is to be appointed archimandrite is conducted to
his place, and he inclineth himself to his girdle thrice before the
Archpriest, and boweth his head. And the Archpriest, sitting, signeth
him with the hand upon his head thrice. And if he that is to be
appointed archimandrite be not an abbot, the Archpriest saith over
him the prayers which are said over an abbot. But if he be already an
abbot the prayers for an abbot are not said over the archimandrite,
and the protodeacon only saith with a loud voice,
Bid, master.
And the Archpriest exclaimeth with a loud voice,
The grace of the all-holy Spirit, through our mediocrity, appointeth
thee archimandrite of the honourable habitation of our Lord, God,
and Saviour, Jesus Christ, or, of our most holy God-bearing Lady,
whatever temple of her it may be, or, of Saint, name, to whom may
be dedicated the temple.
Then the Archpriest, laying his hand on the head of him that is
appointed, exclaimeth Axios, thrice.
And the singers sing, Axios, thrice.
And if, by the command of our Most Pious,
Autocratic Great Lord, THE EMPEROR
ALEXANDER ALEXANDROVITCH of
 all Russia, and with the blessing of the Most Holy
Governing Synod, the mitre be given to the archimandrite,
then after the procession from the altar
with the gospel at the divine liturgy, the archimandrite
is conducted to the Archpriest. And the
Archpriest doth not say the prayer, but only blesseth
the archimandrite with the hand. And he kisseth
the Archpriest’s hand, and the mitre; and they
place the mitre on the archimandrite. And, being
conducted, he rangeth himself with the archimandrites
and abbots according to degree,
and they go into the altar through
the royal doors, and he acteth
with the ministers
according to
rite.
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