Lecture 12 Quiz

Model Answers Submitted By Students

  1. Receiving $100 next year is not the same as receiving $100 today because of the _________________.

It is not the same because of the opportunity cost and the ability to earn interest on the $100.00 (Matt P.)

  1. Free enterprise does not cause interest rates. Impatience does! Explain both views.

… I know that I would not loan a large amount of money to somebody with no assurance of getting it back without some kind of benefit to myself. Unless it was someone I really trusted. This is a form of the free market because I am able to choose how to run my own business and make money. (Kris T.)

Fee enterprise basically is where there aren’t any real regulations on the market, so this allows people to set things where it is more profitable. An interest rate gives people the chance to make more money. … (Sarah C.)

… Impatience can cause interest rates by causing people to borrow money in order to immediately be able to buy something (probably something expensive like a car or a house), rather than waiting to earn the money themselves over a period of time. (Gregory J.)

Impatience causes interest rates because people want their money now, and if they don’t get it, they want extra money as payment for their time spent waiting. (Sarah S.)

  1. I agree to pay you $1,000 in one year, if you pay me ______ today. The interest rate is 5%. Fill in the blank, showing your work.

x = 1000/(1+.05) = $952.38 = Original payment. Interest is $47.62 (Alyssa G.)

I agree to pay you $1000 in one year, if you pay me $952.38 today. The interest rate is 5%. The interest that I pay is $47.63. (Abby L.)

  1. Sarah S. owns a clothing store. She can spend $100,000 today to increase her inventory of fancy clothes, which would increase her profits by $104,000 in one year without any further benefit. Interest rates are 5%. Should she make the investment?

Sarah shouldn’t make the investment because if she kept that $100,000 and put it to work in the stock market, the bank, a CD, etc., she could be gaining money on it; more than $104,000. (Anthony B.)

  1. Many students missed this question on the exam: If total utility is maximized, then

(a) average utility is minimized

(b) average utility is maximized

(c) marginal utility is maximized

(d) marginal utility is zero

Answer this question correctly this time, and explain your answer.

(d). If your utility can’t go any higher, than the utility for one more thing is zero. (Kevin H.)

The answer is (d) because if total utility is maximized, there is nothing left over. (Scott J.)

  1. The New York Yankees drafted Chris R. as a good left-handed pitcher, a rare type of player, and pays him $200,000 for his first year in the minor leagues. Outside of baseball, his wage would be $30,000 a year. What is his economic rent?

… The Yankees are willing to pay a premium for special ability. Thus the economic rent is $170,000, enjoyed by me at the expense of Steinbrenner. Since they have spent over $180 Million for such a lousy team, an extra $200,000 for such rare talent would be well worth the money. (Hey Mr. Schlafly, if this ever happens to me, I will send you tickets to my home games, and hot dogs will be on me!) (Chris R.)

Chris’s economic rent for his first year in the minor leagues is $170,000 ($200,000-$30,000). It is his surplus at the expense of the person (the NY Yankees) paying it. (Rebecca B.)

  1. Many people missed this question on the exam: All of the following are fixed costs for starting a new school EXCEPT:

(a) textbooks

(b) electricity

(c) rent

(d) landscaping

If you answered this incorrectly on the exam, then explain it correctly now. If you answered this correctly on the exam, then pick another problem that you missed and explain it correctly.

(a) because the cost of textbooks varies with respect to the quantity of output. (Alexandra S.)

All of the following are fixed costs for starting a new school except for the costs of textbooks because if you have one student you only have to buy one textbook but if you have 15 students then you have to buy 15 textbooks therefore not making it a fixed cost. (Zack S.)

The answer is (a). The definition of fixed cost is a cost that remains constant, regardless of any change in a company’s activity. Electricity, rent and landscaping are not affected by the addition of other students. The cost that you spend on textbooks is. It is not a fixed cost. (Lisa H.)

The correct answer is (a) textbooks. This is correct because the number of textbooks that needs to be purchased depends on the number of students. (Tim S.)

  1. During hurricane season a town’s power plant was completely destroyed. People wanted to buy kerosene to run their emergency generators. But the price of kerosene doubled! What is the effect of the price increase? Should a new law force the price of kerosene down by half?

The effect of the price increase is that some people may not be able to afford to pay for the kerosene; however, there will not be a shortage. If a law forces the price of kerosene down, then people will be able to afford the kerosene, but there will be a shortage (as there has been every time the government put price controls on anything). (Dan L.)

The effect is that many people won’t have power. I don’t think a new law should force the price down, since I despise government regulations and the price will naturally be forced down, because the Law of Demand exists. (Phyllis S.)

This is economic rent because economic rent is the amount that a monopoly can charge in exces of the good’s cost. The effect should be a major economic slowdown. … (Charles A.)

… Prices are a form of rationing, and unless some other rationing system is put into place, a price ceiling law will allow some people to buy as much kerosene as they want or even more, while others will be willing to pay extra for kerosene but can’t find any because others have already cleaned out the stores. (Joseph S.)

  1. Explain what economic rent is in your own words, using your own example.

Economic rent is the amount extra when someone pays more for a good or service that he normally would in a competitive market. For example, if my dad flies down to South America for a business trip, there aren’t that many car rentals at the airport. In fact there’s only one. So instead of around $30 a day which he would pay in LA or Europe, he’s got to pay $50. His economic rent is $20. (Mary Rose B.)

Economic rent is the extra amount that is charged due to the uniqueness of a good. For example if Julius Caesar’s sword costs $100,000 and an ordinary sword just like it costs $1,000 the economic rent would be $99,000. (Brandon M.)

  1. Suppose you were buying a house and agreed to the purchase price. Then, at the last minute, you said that the seller could keep the house for another year and you would pay the same amount next year to buy it and move in then. The seller thought that was a good deal because he got to live in the house for another year. Was he right?

The seller is wrong. The time value of money states that he would be better off either selling it to someone else in a year for a greater price, or demanding that the transaction occur immediately. Unless the seller would gain so much utility from keeping the house for another year, it might be worth it in one sense. But we should assume that everyone is making rational consumer choices. (Sarah B.)

No, he was not. The seller was not thinking about the time value of his money. … (Cara M.)

  1. Explain which of these earn economic rent, and how much: Sarah C. earns $500 for playing her violin at events, but would play for free. Anthony collects $800 for renting his basement, which equals the electricity, property, interest and costs of his time collecting the rent. Lisa, because of her special talent, earns $30,000 a year growing soybeans when others like her only make $20,000 with similar land.

Sarah C.’s economic rent is $500 minus her opportunity costs. If Anthony rents out his basement for precisely the sum of his supply costs and opportunity cost, then he is not earning any economic rent. … [Lisa’s] economic rent is $10,000. (Eric J.)

Sarah C. and Lisa both earn economic rent. … Anthony doesn’t have economic rent because he is selling at supply cost. (Chris B.)

  1. Explain Jesus’ parable about the talents, using general principles learned during this course.

… The third servant had an opportunity cost of the interest money he could have earned if he had invested. He should have invested because of interest rates and the time value of money. (Kirstin L.)

… While the other two servants invest and increase their master’s money, [the third servant] leaves the money in a hole in the ground, where the opportunity cost of the interest he could have made on it accumulates, and the money gradually loses value as additional wealth is created in the world (… after a long time the master of those servants came and settle accounts with them.). There is also another concept at work in this parable, although in a more subtle fashion: the invisible hand. In the parable, two servants go and use their master’s money for productive purposes, and they are rewarded. But the third servant was slothful and failed to do anything productive to increase his master’s money, and he loses even what he started out with. This is an excellent illustration of how the invisible hand works: productive members of society are rewarded, while the lazy and slothful suffer the consequences of their inactivity, forcing people to be productive whether they like it or not. (Chris J.)

… Since the last servant decided to bury it the value decreased. The other two traded and made double of what they were given and maximized their Master’s utility. The two that trade their talents made enough to cover the decreased value of them. (Jessica H.)