Problems set 1

Economic Analysis
Due: Thursday, February 6, 2014 in class

Instruction
Please type your answer free of grammatical and spelling errors. (Five points will be deducted from
un-typed assignment)
Staple the answer sheet (unstapled answer sheet will be penalized by 5 points)
Please submit the assignment in class. Online/email submission will not be open and thus be not
graded.

1. Ha Arkes, a psychologist at Ohio University, asked 61 students to assume that by mistake theyd
purchased tickets for a $50 and $100 ski trips for the same weekend. The students were informed
theyd have much more fun on the $50 trip. They were then told they had to choose between the two
trips and let the other ticket go to waste. How much is the Sunk-cost if students choose to go to the
higher valued $50 trip?1 If you were one of the students, which trip would you choose? Why? (1.5 +
1.5 points)
2. Real estate agents help others sell house and receive commission. Suppose, you have assigned an
agent to sell your house. His commission is 3%. The best price the house can fetch is $320k. But, the
agent will try to sell the house as quickly as possible even though such sell gets him lower
commission. Suppose he convinces you to accept an offer of $280k, $40k less than the best price.
Quantify the incentive motivating the agent to sell the house fast at lower price.2 (2 points)
3. Suppose you are currently holding two concert tickets scheduled at the same time. Column two
presents the prices and column three the values you anticipate to receive from each concert. If you are
a rational individual, which concert you will choose to go and why?3 (2 points)
Concert

Price

Gross value

Clapton

Free

$15

Dylan

$40

$50

4. According to Adam Smith, father of invisible hand and free market, People of the same trade seldom
meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the
public, or in some contrivance to raise prices. Smith also argued that self -interested action often
leads to socially benign outcomes.4 Identify five unregulated individual rational actions that impose
indirect harm to society. Explain why? (1 + 1 points)

GOURVILLE, John, and Dilip SOMAN. 2002. Pricing and the Psychology of Consumption. Harvard Business
Review 80(September):90-96.
2
Levitt, Steven D. and Stephan J. Dunber, Feakonomics, William Morrow, 2005
3
Robert Frank, 2007. The Economic Naturalist: in Search of Explanations for Everyday Enigmas, Basic Books.
4
Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, State College, PA: Penn State
University, 2005, p. 111 (originally published in 1776).

5. How corporate CEOs acting rationally are likely to harm owners (stock owners) dividend? (See
Incentive Matters, Chapter 2 from Naked Economics by Charles Wheelan) (1points)5

6. Using the demand for chicken data in the blackboard, estimate the log-linear demand function. (2
points)
7. Specify the estimated demand equation.

8. Calculate the price elasticity demand for chicken. Is chicken an elastic or inelastic item? (1 point)
9. Income elasticity demand for chicken. (1 point)
10. From the income elasticity value, identify whether chicken is a normal good, a luxury, a necessity or
an inferior product. (1 point)
11. From the estimates, identify the substitutes and complements of chicken. (1 point)

Incentives Matter: Why you might be able to save your face by cutting off your nose (if you are a black
rhinoceros in Naked Economics: Undressing the Dismal Science by Charles Wheelan, 2003, WW Norton

Answers
1. The sunk cost is $100 dollars because that is the price of the other trip and you cannot get that
money back. I would choose the $100 trip because even though you might have more fun on the
$50 trip the total sunk cost will only be $50 instead of $100.
2. The agent loses $1200 in commission for selling the house at 40k less but if it takes him a

week to sell the house then he can start on selling another house. But if it took him two
weeks to sale that house then the only benefit is the commission of the additional 40K of
the sale. Whereas, he could have earned commission on $100k or more on another house.
3. I would go to the Clapton concert because my marginal benefit is $15, whereas my

marginal benefit for going to the Dylan concert is only $10.

4.
5. Self-preservation is simply human nature, but sometimes it comes with a cost that is call perverse
incentives. CEOs may use a companys assets to position themselves in a good way but this
positioning can be harmful to the company as a whole. If the CEO takes a vacation using the
companys jet it benefits him but it costs the company money that could have been used to issue
dividends.
6. Q = 1.06 + 0.35 0.59 + 0.37 + 0.34 0.45
7. Q = 38.6 + 0.005 0.65 + 0.24 + 0.104 0.07
8. -0.65 and it is inelastic
9. 0.005
10. Chicken is a normal and a necessity good.
11. Beef and pork are substitutes to chicken.