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ECON 402 Study Guide - Quiz Guide: Pearson Education, Marginal Utility, Marginal CostExam


Department
Economics
Course Code
ECON 402
Professor
William Crowley
Study Guide
Quiz

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CHAPTER 1 | Economics: Foundations and Models 1
Copyright © 2017 Pearson Education, Inc.
1.1
Three Key Economic Ideas
Learning Objective: Explain these three key economic ideas: People are
rational; people respond to incentives; and optimal decisions are made
at the margin.
Review Questions
1.1 “People are rational” is the assumption that decision makers explicitly or implicitly weigh
the benefits and costs of each action and then choose an action only if the benefits are
expected to outweigh the costs. “People respond to incentives” by changing their
behavior in response to an economic incentive. For example, if health insurance reduces
an individual’s medical costs from being obese, it may give people an incentive to gain
weight. “Optimal decisions are made at the margin” means that most decisions are not
“all or nothing,” but involve doing a little more or a little less of an activity. Therefore,
the optimal decision is to continue any activity up to the point where the marginal benefit
equals the marginal cost.
1.2 Scarcity is the situation in which unlimited wants exceed the limited resources available
to fulfill those wants. Economics is the study of the choices consumers, business
managers, and government officials make to attain their goals. Scarcity is central to
economics because scarcity requires people to make choices about how to use their
resources to best fulfill their wants. In making choices we must give up other
opportunities that we value. What we give up (our second-best choice) is called the
opportunity cost of our choice.
Problems and Applications
1.3 Economists assume that people are rational in the sense that they use all available
information as they act to achieve their goals. Rational individuals weigh the benefits and
costs of each action, and they choose an action only if the benefits outweigh the costs.
Economists do not assume everyone is a genius or always makes the “right” decision in
every circumstance; rather, economists assume that the actions of consumers and
businesses reflect their attempts to achieve their goals.
1.4 As noted in the chapter, the economic incentive to banks is clearit is less costly to put
up with bank robberies than to take these additional security measures. The marginal cost
of adding the additional security is greater than the expected marginal benefit.
1.5 a. Students face a scarcity of time, like everyone else, and respond to the incentives of
the teacher’s grading system. Students have more incentive to put their efforts into
the parts of the course that have the most weight in the grading system.
b. Putting too little weight on outside readings, or similar assignments, gives students
little incentive to read and master the material. Students will put less effort into the
parts of the course that have little effect on their grades.

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CHAPTER 1 | Economics: Foundations and Models 2
Copyright © 2017 Pearson Education, Inc.
c. Quizzes on assigned readings would give students an incentive to come to class
having read the upcoming material. Some teachers give preparation assignments
where students have to read and answer questions about the upcoming material, and
over the course of the semester students have to successfully complete a certain
percentage of the preparation assignments to qualify for an A, B, or other grade in the
course.
1.6 a. As a result of changes in the federal student loan programs the total amount students
borrow should increase. The changes increase the incentive students have to borrow
money under the programs because they limit the amount of the loans that must be
repaid.
b. If in 2016 President Obama was recommending further changes to the student loan
program, then it’s likely that the 2011 changes to the program had results that were
not expected. The most likely unexpected result is that because the 2011 changes
resulted in students having to pay back less, students were borrowing more money
than the president and his advisers had anticipated. So, in 2016 it’s likely that
President Obama recommended changes that would increase the loan repayments
borrowers would have to make.
c. President Obama and his advisers may have failed to take into account that the 2011
changes to the program changed the incentives students faced. Because the incentive
to increase the amount borrowed increased, President Obama and his advisers
underestimated the increase in the amount the federal government would have to pay
in loan subsidies.
1.7 a. Employees who have health problems incur higher medical costs than healthier
employees. The higher medical costs increase the health insurance premiums that
firms must pay
for employer-provided health insurance, which raises the firms’ costs. These higher
costs provide an incentive for universities and corporations to encourage employees
to improve and maintain their health.
b. Improvements in health result in a monetary reward, although a small one. This
reward is a positive incentive for employees to improve or maintain their health.
c. A wellness program, if successful, would decrease the premiums that an insurance
company would charge. Healthier employees would have fewer health problems that
would be covered by a university’s or a corporation’s insurance plan.
1.8 a. Obese workers tend to suffer more medical problems than do people who are not
overweight and so incur higher medical costs. The higher medical costs increase the
health insurance premiums that firms must pay for employer-provided health
insurance, which raises the firms’ costs. Obese workers raise a firm’s costs compared
with the costs of workers who are not obese and who are paid the same wage. Paying
lower wages to obese workers helps firms to offset these higher costs.
b. Bhattacharya and Bundorf found that firms that provide health insurance pay lower
wages to obese workers than to workers who are not overweight, but that firms that
do not provide health insurance pay obese workers the same as workers who are not
overweight. These findings imply that obese workers incur higher medical costs,
pushing up health insurance premiums, and would be consistent with the idea that
health insurance provides people with an incentive to become obese.

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CHAPTER 1 | Economics: Foundations and Models 3
Copyright © 2017 Pearson Education, Inc.
1.9 You would want to compare the expected additional revenue with the expected additional
cost of serving breakfast all day. Your revenue calculations should include the effect of
some customers buying breakfast instead of the more expensive lunch or dinner meals,
and your cost calculations should include any extra employees or grills needed to prepare
breakfast and lunch or dinner meals at the same time. The decision would not have to be
all or nothing. Depending on the effect on additional revenue and additional cost,
McDonald’s could decide how long to extend breakfast hours and which breakfast items
to include on its menus.
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