Ch05-AK

1) Kiva loans do not pay interest to the lender, unlike a typical bank account. By investing with Kiva, you forego interest. This opportunity cost is an economic cost, but not an accounting cost.

2) For this question, pay particular attention to the SRMC, SRATC, and SRAVC curves, and where they do (or don’t) cross each other. The SRAFT curve is superfluous, but I wanted you to understand that as you increase the quantity of production, average fixed costs decrease in importance. I’m not concerned with where this curve intersects the others.

3A)

Cars/Day 0	Labor Hours 0	Fixed Cost 90	Variable Cost 0	Total Cost 90	Marginal Cost NA	Average FC NA	Average VC NA	Average TC NA
1	20	90	200	290	200	90	200	290
2	30	90	300	390	100	45	150	195
3	36	90	360	450	60	30	120	150
4	45	90	450	540	90	22.5	112.5	135
5	60	90	600	690	150	18	120	138

3B) Marginal costs begin to rise when the 4^th car is produced.

4) The clear answer to this question has to do with opportunity costs. People from disadvantaged backgrounds (whether income or educational) face lower opportunity costs of serving in the country’s military than more privileged individuals (or presidents) would experience. Aside from ethical considerations, overrepresentation of poor (rural) men and women in the military has made it more difficult for the US government to provide veterans with health services when veterans return home. To learn more about this issue, see http://pn.psychiatryonline.org/cgi/content/full/42/10/12.

5A) The purpose of this experiment is to illustrate that sometimes firms’ costs don’t fit neatly into economists’ models. Sometimes, economists have trouble analyzing strange markets. Three “products” make good examples. Note, however, that none of these examples is perfect, since “victory” is not guaranteed by spending the most money.

· The market for elected politicians. Usually, two or more people compete for one position by raising money and campaigning for votes. The person who wins receives the office. The person who loses receives nothing despite spending fast sums of money on his/her campaign.

· Research and Development (R&D) efforts. Example: Toshiba and NEC jointly developed the HD DVD as the replacement for home video viewing. At the same time, Sony developed its Blu-Ray player. One of these formats is likely to be much more successful than the other. Thus, one inventor will have spent massive amounts of money on a successful invention, while the other just wasted a lot of time, money, and talent on an invention that no one wants.

· Poker hands. A person may be able to successfully bluff (or bully) competitors out of hands by betting the most money. One difference in this scenario is that the winner gets to keep his/her bid and doesn’t have to pay it to anyone else.

5B) We really haven’t discussed what “efficient” means yet, but you probably have a sense that if one person (or company) spends time, money, and resources on a project that ultimately fails, the market probably is not efficient.

5C) The total cost is $202. The marginal cost is two dollars. The sunk cost (a topic to be covered later) is simply the $200 you have already committed to spend. It should not enter into your decision making process, because you no longer have any control over that amount of money. Instead, it is rational to continue bidding as long as the marginal benefit (your expectation of winning $200) exceeds or equals your marginal cost ($2). Of course, your opponent faces the same dilemma, so the bidding can continue until all funds are exhausted and you have bid every dollar you have. (Do you see why presidential campaigns are so expensive?)

5D) If you know the value of the product on which you are bidding, you can bid that amount immediately. Your opponent faces no incentive to bid if his/her marginal cost of beating your bid exceeds the marginal benefit. A student in a previous class recognized another successful strategy: Find out what your opponent’s budget constraint is, and bid that amount. Assuming your opponent has no ability to borrow money to place another bid, you are guaranteed to win the auction.

Note that this strategy may work in poker as well. If you bet an exorbitant amount of cash in the first round of betting, you may be able to successfully bluff (and bully) other competitors out of the game and win their antes (or blinds). Note, however, that this strategy has very little payoff and can result in huge and embarrassing losses if people with strong hands remain in the game.