Economics Homework Eleven - Model

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1. If you were to loan someone money, why would you want him to pay you something extra (interest) when he pays back the loan? Give at least one reason.

Instead of loaning money, I could invest the same amount of money and earn more. Interest makes it profitable to loan money. (Mark)
I would want him to pay interest because the interest will pay for the service I am giving him by letting him use my money. (Isaac)
When you loan someone money, there is the risk of him never giving your money back. Money also has an opportunity cost. By loaning out your money you lose the interest it could be earning in the bank, or a better way of investing it. For these reasons, you want to be compensated for loaning out your money. This the point of charging interest. (Sean)

2. Suppose I loaned you $1000 today, and interest rates are 5% per year (compounded annually), and you repaid the loan plus interest in 2 years, then what is the total you would pay to satisfy this debt?

$1,000 x 1.05 = $1,050 ----- $1,050 x another 1.05 = $1,102.50 So, I would pay you $1,102.50 to satisfy the debt. (Trish)

3. Review: is the cost of the bus for a trip to D.C. a "fixed cost" or a "variable cost"? Explain, assuming for the purpose of this question that one and only one bus can be used (in reality, we may have several buses).

The cost of the bus for a trip to D.C. is a fixed cost, because the price of the bus won't change whether one person goes down or the bus is full. (Seth)
A "variable cost" is one that "varies" with output. In this case, the cost of the bus does not "vary" with output, and thus it must be a fixed cost. (Instructor)

4. Which concept in Economics do you think is the best self-motivator, which you might use to achieve more?

“Carpe Diem”, seize the day, motivates you to accomplish as much as you can in the time you are given. You would use your time wisely if it was to be your last day on earth. We do not take the possibility of not having the privilege of living tomorrow it seriously. So live each day to the fullest as if it were your last. (Veronika)
It is most likely competition or profit since both are great motivators. Competition gives people the will to win and profit is the reward. (Aran)
Time is money: this concept shows that the more time is put to good use, the more profitable the time will be. (Zachary)

5. Suppose I will pay you $1000 in two years, and the interest rate is 10% per year, compounded annually. How much should you pay me today to receive $1000 in two years? Show your work.

To find the amount paid the second year, divide $1000 by 1.1. Then you take that number and you divide that by 1.1 again, and your result is $826.45, which is the answer. (Anna)
The answer can be found by dividing $1000 by 1.10 twice to find the answer, $826.45. (James)

6. Pick another question from the midterm exam that you answered incorrectly, and explain the correct answer.

(Answers varied.)

7. Explain what “economic rent” is in your own words, using your own example.

Economic rent is a return greater than the normal profit/return for that particular good or service. It is the additional revenue you get for having a good/service that is in high demand, without having put any more money into your product, simply because your product is unique in some way. For example, there are Pop Tarts, and then there are the store brands. They are fairly good substitutes, but the prices are much higher for Pop Tarts. They receive economic rent on that good simply because they are better known. (Michelle)

8. An agreement by different firms with each other to reduce output is illegal. Why should that be illegal?

This should be illegal because it is an attempt to create a monopoly out of the public eye. It could also be described as creating economic rent that would not exist in the unmanipulated market. Reducing output impedes the free market and causes loss of wealth, and to impede the market unnecessarily to make more money is harmful to the consumers. In fact, banning false reduction of output is a less involved procedure than breaking up a monopoly, and so possible harm due to regulation is also diminished by making this illegal. (Addison)
It is a cartel, and because it causes higher prices and less quantity. (Sarah)

9. What is your favorite concept in Economics, and why?

I like the concept of the invisible hand: one of mankind's great flaws--greed--is turned for the benefit of society. (Duncan)
My favorite economics concept is cross elasticity because I find it interesting to see how one good can affect another. (Courtney)
Coase Theorem is my favorite because it reminds us that the only obstacle to an efficient market is excessive transaction costs. (Elizabeth)
Price elasticity - Because I can relate it to the world around me and I can understand the reasons behind what stores are doing. (Kate)

10. Nash equilibrium, revisited: What is the Nash equilibrium for two gas stations (an oligopoly) that are situation immediately across the street from each other? In other words, what price do they sell at, expressed in terms of one of their cost measures? Explain the process that reaches that "equilibrium".

Consider as a starting point high sales prices by each gas station, much higher than marginal cost (marginal cost is a "cost measure"). Next notice that the high prices won't be the equilibrium, because one station can earn more profits by slightly lower his price to pick up many new customers, as many people choose his station for his slightly lower price. But then the other station does likewise to win the customers back, and this same pattern of underselling the other guy each other continues again and again ... until the sales price falls to the level of the marginal cost. At that point neither station is better off by lowering his price further, because then he would be selling BELOW marginal cost and losing money on each sale. So the Nash equilibrium for this oligopoly is where marginal revenue equals marginal cost, which is the same as in a fully competitive market. (Instructor)