Assignment No.

Micro Economics

SYED ATIF ALI

GR NO. 230633
Q1
a. A family deciding whether to buy a new car?

Ans: A family deciding whether to buy a new car faces a trade-off between the cost
of the car and other things they might want to buy. For example, buying the car
means they must give up going on vacation for the next two years. So the real cost
of the car is the family's opportunity cost in terms of what they must give up.

b. A member of congress deciding how much to spend on national parks?

Ans: For a member of Congress deciding whether to increase spending on national

parks, the trade-off is between parks and other spending items or tax cuts. If more
money goes into the park system, that may mean less spending on national defense
or on the police force.

c. A company president deciding whether to open a new factory?

Ans: When a company president decides whether to open a new factory, the
decision is based on whether the new factory will increase the firm's profits
compared to other alternatives. For example, the company could upgrade existing
equipment or expand existing factories.

d. A professor deciding how much to prepare for class?

Ans: In deciding how much to prepare for class, a professor faces a trade-off
between the values of improving the quality of the lecture compared to other things
he could do with his time, such as working on additional research.

Q2
Ans: When the benefits of something are psychological, such as going on a vacation
then there are two ways to think about the benefits. One is to compare the vacation
with what we would do in its place. If you did not go on vacation, we may buy
something or second way is to think about how hard we had to work to earn the
money to pay for the vacation.

Q3
Ans: If we are thinking of going skiing instead of working at your part-time job, the
cost of skiing includes its monetary and time costs, which includes the opportunity
cost of the wages which we are giving up by not working. If the choice is between
skiing and going to the library to study, then the cost of skiing is its monetary and
time costs including the cost of getting lower grades in this course.

Q4
Ans: If we spend $100 now instead of saving it for a year and earning 5 percent
interest then we are giving up the opportunity to spend $105 a year from now.
Q5
 Ans: The fact that we have already sunk $5 million is not relevant to your decision
anymore, because that money is gone. What matters now is the chance to earn
profits at the margin. If you spend another $1 million and can generate sales of $3
million, we will earn $2 million in marginal profit, so you should do so. If we do not
spend the additional $1 million, we will not have any sales and losses will be $5
million. So what matters is not the total profit, but the profit we can earn at the
margin. So we should pay up to $3 million to complete development.

Q6
Ans: Harry suggests looking at whether productivity would rise or fall. Productivity is
certainly important, since the more productive workers are, the lower the cost per
gallon of potion. Ron wants to look at average cost. But both Harry and Ron are
missing the other side of the equation i.e. revenue. A firm wants to maximize its
profits, so it needs to examine both costs and revenues. Thus, Hermione is right, it is
best to examine whether the extra revenue would exceed the extra costs.

Q7
Ans:
a. The provision of Social Security benefits lowers an individual’s incentive to save
for retirement. The benefits provide some level of income to the individual when he
or she retires. This means that the individual is not entirely dependent on savings to
support consumption through the years in retirement.

b. Since a person gets fewer after-tax Social Security benefits the greater his or her
earnings are, there is an incentive not to work (or not work as much) after age 65.
The more we work, the lower your after-tax Social Security benefits will be. Thus, the
taxation of Social Security benefits discourages work effort after age 65.

Q8
Ans:
a. When welfare recipients have their benefits cut off after two years, they have a
greater incentive to find jobs than if their benefits were to last forever.

b. The loss of benefits means that someone who cannot find a job will get no income
at all, so the distribution of income will become less equal. But the economy will be
more efficient, because welfare recipients have a greater incentive to find jobs. Thus,
the change in the law is one that increases efficiency but reduces equity.

Q9
Ans: By specializing in each task, you and your roommate can finish the chores more
quickly. If you divided each task equally, it would take you more time to cook than it
would take your roommate, and it would take him more time to clean than it would
take you. By specializing, you reduce the total time spent on chores. Similarly,
countries can specialize and trade, making both better off. For example, if Pakistan is
better in agriculture and Singapore has an edge in scientific technology then they
can sign a treaty that in exchange of agriculture goods, Pakistan would get technical
support and Singapore would get agricultural goods.
Q12
Ans:
a. If everyone were guaranteed the best health care possible, much more of our
nation's output would be devoted to medical care than is now the case. If the
government mandated increased spending on health care, the economy would be
less efficient because it would give people more health care than they would choose
to pay for. From the point of view of equity, if poor people are less likely to have
adequate health care, providing more health care would represent an improvement.

b. When workers are laid off, equity considerations argue for the unemployment
benefits system to provide them with some income until they can find new jobs. After
all, no one plans to be laid off, so unemployment benefits are a form of insurance.
But there is an efficiency problem because if you can get income for doing nothing?
The economy is not operating efficiently if people remain unemployed for a long time,
and unemployment benefits encourage unemployment. Thus, there is a trade-off
between equity and efficiency. The more generous unemployment benefits are, the
less income is lost by an unemployed person, but the more that person is
encouraged to remain unemployed.

Q13
Ans: Because average income in the United States has roughly doubled every 35
years, so new generation in USA have a better standard of living than their parents,
and a much better standard of living than grandparents. This is mainly the result of
increased productivity, so that an hour of work produces more goods and services
than it used to. Thus, incomes have continuously risen over time, as has the
standard of living.

Q16
Ans:
Story 1: Hoard instinct

The nature of the recession, not government schemes, may explain why some
countries lost so few jobs

Jul 8th 2010

GERMANY’S gross domestic product fell by 4% in the two years to the end of 2009,
twice as much as in America. Yet its employment rose by 0.7% while America’s
plunged by 5.5%. When German politicians contemplate why a grueling recession
produced almost no increase in unemployment, they usually have a one-word
answer: Kurzarbeit. “It is only thanks to Kurzarbeit that more jobs were not lost,”
Angela Merkel, the chancellor, told Germany’s parliament in November.

Kurzarbeit is Germany’s practice of providing a federal subsidy to companies that

voluntarily reduce the hours of their employees while keeping them on the payroll. It
is perhaps the best known of many short-time work programs implemented or
expanded during the recession by countries trying to defray the social and economic
costs of unemployment. But such schemes only partly explain why employment in
many countries, Germany included, diverged so greatly from output. Other reasons
can be found in the OECD’s annual “Employment Outlook”, published on July 7th.
(But only after a lot of digging: the 308-page report is a dense mass of impenetrable
jargon, a frustrating way to treat a subject so vital to the average citizen.)

Judging the net impact of short-time work schemes on permanent employment is not
simply a matter of counting all program participants. Some people would have stayed
in employment anyway and so the subsidy is wasted on them. Others are sacked
while the program is still running or when it ends—their job is not truly saved. To
glean its net impact the OECD compares employment across countries with the
extent to which short-time working was used. It concludes the average scheme
boosted permanent employment by 0.4% relative to what it would have otherwise
been. The size of the boost varied considerably, from 1.3% in Belgium to zero in
Norway (see right-hand chart). It estimates that the net impact for Germany, at
220,000, is considerably less than the 350,000 jobs officially preserved by
Kurzarbeit, suggesting that a third of the subsidy was wasted.

That is still nothing to be sniffed at. The net benefit translates to a 0.75% boost to
permanent employment in Germany, enough to cover the entire increase in the
country’s employment between the fourth quarter of 2007 and the end of 2009. Yet
this effect is not big enough to explain the enormous divergence between its steady
unemployment rate and its falling GDP. In Germany and elsewhere many companies
cut hours or held onto idle workers (as evidenced by falling productivity) without any
prod from government. A study by the Federal Employment Agency in Germany
concluded that Kurzarbeit explains only a quarter of the reduction in the average
work week. The remainder came from employers reducing overtime or workers’
hours under contract provisions with unions; or by workers taking free time stored up
in working-time accounts before the downturn.

The path of economic recovery may partly depend on whether employment stayed
firm because of companies’ own decisions rather than government subsidies. Short-
time work schemes introduce distortions: they could impede growth and productivity
once recovery begins by discouraging workers from moving from firms in declining
industries to growing ones. Firms that hoard workers voluntarily do so because they
expect to need them when business bounces back and, having invested heavily in
their training, do not want the expense of replacing them. That suggests a more
upbeat view of the future.

In fact, employment is unlikely to spring back sharply anywhere in the OECD but for
very different reasons. In countries where a collapse in housing and construction was
a big contributor to the recession, notably Spain, America and Ireland, firms were
much more likely to slash employment and raise the productivity of remaining
workers, believing the recession signaled a structural decline in the importance of
construction. Long-term unemployment has risen as a share of total employment,
reflecting both the length of their recessions and permanent job losses in industries
like construction. Both factors will make it difficult rapidly to re-employ the jobless.

Kinder cuts
In countries whose recessions were due largely to falling exports, such as Japan,
Mexico, Germany and Korea, the OECD notes that companies were more likely to
cut hours and productivity than jobs. The export drop “might plausibly have been
viewed as being a largely transitory phenomenon”, reflecting global conditions rather
than a structural change in the economy. Such firms are also more likely to use
highly skilled labor, and the report reckons that these companies are far less prone
to cut employment when sales fall. That also means that Japan, Germany and other
countries where firms hoarded labor are at greater risk of a jobless recovery: higher
production will be achieved by restoring hours and productivity rather than payrolls.
But that is not a bad thing if it is because employment fell so little in the first place.

Short-term work program have played their part in softening the effects of recession.
Although they may yet slow the movement of employees from declining companies
to more productive employers, most governments in Europe have wisely resisted the
remedies of previous recessions, such as early retirement or easier qualification for
disability benefits that hurt their long-term labor-force growth. But the independent
decisions of firms to hoard labor also help explain unemployment during the crisis
and beyond. Just because bosses expect business to rebound does not mean they
are right, of course. If the global economy, and thus exports, proves weaker than
businesses hoped, they may start to fire the workers they had previously hoarded,
irrespective of the government incentives on offer.

Conclusion
I think it follows Principle no. 1 because according to principle no. 1, People face
trade-offs because to get one thing that they like to secure jobs and in return they
are giving up i.e. opportunity cost are high salaries, allowances and overtimes. On
the whole it is beneficial for both employees and employers as well as government
because in return employees secure their jobs, employers retains their human
resources i.e. best hands for the future use and government hoard unemployement
allowances (for Welfare States like Canada, USA, UK and etc.).

Story 2: Racing green

Skills learned in motor sport are driving the development of low-carbon cars

Jun 17th 2010

WHEN, late last year, Lord Mandelson proclaimed that he wanted Britain to become
“a world leader in low-carbon transport”, most dismissed it as a typical example of
New Labour hyperbole.

But the former business secretary was right in a way that even he may not have
realized. The rarefied technological skills and talent for fleet-footed innovation that
have made Britain home to much of the international motor sport industry are now
being applied to develop some of the most interesting, possibly revolutionary, ultra-
low-carbon vehicles envisaged anywhere.

The charge is being led by race-bred engineers, such as Gordon Murray, the
designer of four Formula One world-championship-winning cars for McLaren and of
the firm’s legendary 230mph F1 road car. Mr Murray left McLaren because he was
determined to invent a car—and a manufacturing process to go with it—that had the
lowest possible environmental footprint while still being safe, fun to drive and cheap
to buy. He saw the project as creating a “new British Mini for the 21st century”—
much more faithful to the original’s legacy than BMW’s bloated successor. To that
end, three years ago he established a design firm near Guildford with backing from
MDV, a Silicon Valley venture-capital outfit specializing in green technology.
 Some of the principles behind Mr Murray’s car come straight from motor sport: very
light weight, great strength, efficient packaging and compact dimensions. The
difference is that, in Formula One, performance is pursued without heed to cost,
whereas Mr Murray wanted a car that could be built and sold profitably at a price
similar to today’s most basic city cars.

The result is a radically new way of making cars and the T.25, a vehicle every bit as
impressive in its way as the 100 times more pricey McLaren F1. It is smaller than
Daimler’s two-seater Smart, but can carry three in comfort, with the driver sitting in
the middle, and has enough space in the boot for the weekly shop. Three T.25s can
park abreast in one standard parking place. It meets the highest safety standards.
Accident-repair costs are low, thanks to easily replaceable carbon body panels. With
a 660cc engine, the car will accelerate at the pace of a 2-litre saloon and return
80mpg.

Mr Murray is also developing a battery-powered version—the T.27—with the help of

Zytek, a British firm that pioneered engine-control systems for racing cars and is now
a world leader in electric drive trains (it is responsible for the electric version of the
Smart). Because the car is so light a relatively small (and thus inexpensive) battery
will give it a range of 100 miles.

Equally important is the “iStream” process used to make the T.25. “We’re selling a
manufacturing system as much as a car,” says Mr Murray. By doing away with metal
presses, and with assembly simplified by a tubular-frame chassis, Mr Murray reckons
the capital cost of a factory making 100,000 T.25s a year would be about a fifth of
the cost of a conventional plant. Nine carmakers, he says, are considering licensing
the system, but interest extends beyond the automotive industry.

The approach taken to sustainable personal mobility by Riversimple, a company

founded by another ex-racer, Hugo Spowers, is equally unorthodox. Its car, if
anything, takes the gospel of lightness even further—Mr Spowers calls it “mass
decompounding”—allowing it to use a tiny 6kW hydrogen fuel cell to power electric
motors in each wheel. Fuel cells have long promised pollution-free driving, but have
been held back by their enormous cost when applied to a normal car.

Riversimple, which is raising £20m in second-round financing and is backed by

members of the Piëch family who founded Porsche, believes its “whole system
design” philosophy and business model overcomes that obstacle. Mr Spowers
intends to lease rather than sell the car, which has a range of 240 miles and will
accelerate briskly to its top speed of 50mph. That way he can spread the cost of the
critical weight-saving but expensive carbon composite structure over a vehicle’s
lifespan of 15-20 years. Drivers will pay £200 a month and 15p a mile to cover all
their costs, including fuel. In contrast to a conventional carmaker, says Mr Spowers,
Riversimple will have an economic interest in lowering running costs and increasing
longevity. Government-backed trials involving up to 30 cars will begin in Leicester
and, probably, Oxford in 2012.

Mr Murray and Mr Spowers both believe that if cars (and indeed the planet) are to
survive they must be designed, manufactured and used in ways very different to the
century-old model that still holds the automotive industry in thrall. Their companies are
small and specialized, but may hold the key to something much bigger.

Conclusion
It follows Principle no. 4, Mr. MC Murray give up good job from McLaren, the
manufacturer of Formula to get more fame and money by inventing Low Carbon Car and
he was succeeded. This story also reflects Principle no. 3 that the Rational people think
at the Margin so the manufacturer of these cars are interested to invent and manufacture
low cost cars to reduce their operating cost and in return consumer gets low price cars
and again consumer has also follow principle no.4 to get more incentive in term of low
cost and low fuel consumption in terms of electricity or solar light. If we further review
this story, we also conclude that principle no. 1 also applies on Mr. Murray scarifies
operating cost in term of job and time for the R&D for the new green car.

Story 3: The Government will have to get better at explaining cuts

Jul 8th 2010, 14:07 by Bagehot

GIVEN that the coalition government is going to be announcing many cuts, ministers are
going to have to get better at explaining their plans.

Michael Gove, the education secretary, spent what seemed like hours apologizing to the
House of Commons yesterday for the bungled announcement of one of the
government's first big moves: the cancellation of the £55 billion Building Schools for the
Future (BSF) program, a Labor government scheme to rebuild or smarten up thousands
of secondary schools. Mr. Gove apologized "unreservedly" for 25 mistakes in a list
issued by his department, spelling out which projects would still go ahead, which were
for the chop and which were still being reviewed. He expressed contrition to MPs cross
that they learned the fate of school projects in their constituencies from the press. He
also offered to apologize in person to a dozen or so schools which were initially told their
building works would go ahead, when in fact they also face the axe.

Mr. Gove earned some grudging praise for his swift apologies: many ministers would
have been tempted to pin the blame on officials. Today, some reporters argue that Mr.
Gove is still in political trouble, noting that even some Tory MPs are up in arms (one is
threatening to bring a bunch of schoolchildren to Westminster to protest), and that he
could face legal challenges from disgruntled schools, local authorities and building firms.
But such protests were surely anticipated by Mr. Gove and his cabinet colleagues.

I wonder if the real lessons to learn may be rather different.

For starters, keep the message simple. Mr. Gove has repeatedly said he is dropping the
BSF program because it was wastefully bureaucratic. That message has been dutifully
repeated by MPs and ministers from the coalition. But does that mean that Mr. Gove is
cutting all money for new school building or repairs? His own colleagues appear
confused, and keen to reassure voters that some money is still available for new
classrooms.
Even John Redwood, a former cabinet minister and right-wing budget hawk, allowed
himself a yelp of dismay on his blog this morning, urging Mr. Gove to make clear that
some money would still be available for school repairs:

In the statement I heard Michael Gove make he was clear in saying he was canceling
the approach of Building Schools for the future because it was an expensive, long
winded and inefficient way of building schools. He did not say he was canceling all new
schools building. Indeed, if he is right and he can save substantial sums on the box
ticking detailed regulatory approach of the old program this could leave him with more
money to spend on bricks and mortar. This message has got entirely lost in the
broadcasts and newspaper stories about cuts, leading most people to think there will
now be no new schools.

This needs turning round as quickly as possible. According to the figures the Coalition
government is going to spend as much on new capital projects as the outgoing Labor
government. In that case they might end up building more schools than Labor for the
same amount of money if Mr Gove is right about how to do it more cheaply.

The second big lesson, surely, is that in an age of austerity the government will have to
work hard to defend not just its cuts, but also the money that it still intends spending. In
this case, I was struck by the way that Britain's local press covered the story.
Understandably, much of the coverage was along the lines of: "Full List of 82 Yorkshire
schools hit by Gove's Axe", complete with anguished quotes from locals.

But there were also sharp comments here and there that Mr Gove still seemed to have
money available for his flagship policy: the "free schools" program inspired by reforms in
Sweden: this would allow interested groups, involving parents, local teachers or
business types to establish new schools outside local authority control.

The Western Morning News quotes a Liberal Democrat county councilor complaining
about the cancellation of work on a school in the market town of Tiverton. According to
the councilor:

"We're not after a trendy free school...That's a pricey fad for London's chattering
classes. We simply need a school building fit for our students and teachers to thrive. It
should have been an easy choice for Mr Gove but he has flunked the Tiverton test."

Supporters of the free schools plan fret that the public has the impression that this policy
is all about building lots of brand new schools. Instead, says one leading think-tanker,
the most important bit of the "free schools" policy involves making it easier to close down
failing schools, and replace them with completely new academies (rather than watch
local authorities endlessly propping up failing schools, as happens now). In many cases,
says the think-tanker, those "free schools" would be opened in existing school buildings.

The real point, surely, is that an age of austerity is about priorities, and explaining those
priorities.

Labor education policy was too often about shiny new buildings and whizzy high-speed
internet connections and laptops. As I understand it, Mr Gove thinks that the quality of
teaching is what really counts, and he is right. Clearly some schools struggle to teach in
clapped-out old temporary buildings that bake in summer and freeze in winter. But
teachers are the key.

I admit I am a bit of a fogy on this front: I was lucky enough to have outstanding teachers
at a series of schools with incredibly antiquated facilities. One was based in a crowded,
converted townhouse with no playground and no canteen (we ate our packed lunches at
our desks, spilling crumbs into our exercise books). Another had about three of the very
first computers in a back room somewhere (BBC computers, for British readers of a
certain age). It did not matter a bit: we had books, and great teachers.

Mr Gove says he is scrapping the BSF program because it is "bureaucratic". That makes
it sound as though he would like to spend the same amount of money on school building
work, if he could find a better way of doing so. If that is true (as some of his colleagues
seem to hope), he might as well say so clearly, and damp down some of the voter
outrage.

Alternatively, if he is in fact saying he has different priorities in an age of limited cash,

and that he would rather channel investment towards better teaching through increased
school choice, he should say that and explain why.

Conclusion

This story follows the principle no. 2 i.e. The cost of something is what you give up to get
it because by avoiding BSF Program, instead of making new schools, the same amount
of money will be used by government for the revamping and repairing of schools
because presently due to economical crises, it is very difficult to address both issue so it
is prioritized to maintain the existing infrastructure.