Problems set 1Economic AnalysisDue: 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?[footnoteRef:1] If you were one of the students, which trip would you choose? Why? (1.5 + 1.5 points) [1: GOURVILLE, John, and Dilip SOMAN. 2002. Pricing and the Psychology of Consumption. Harvard Business Review 80(September):90-96.]

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.[footnoteRef:2] (2 points) [2: Levitt, Steven D. and Stephan J. Dunber, Feakonomics, William Morrow, 2005]

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?[footnoteRef:3] (2 points) [3: Robert Frank, 2007. The Economic Naturalist: in Search of Explanations for Everyday Enigmas, Basic Books.]

ConcertPriceGross value

ClaptonFree$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.[footnoteRef:4] Identify five unregulated individual rational actions that impose indirect harm to society. Explain why? (1 + 1 points) [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)[footnoteRef:5] [5: 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]

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)

Answers1. 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 0.457. Q = 38.6 + 0.005 0.65 + 0.24 + 0.104 0.078. -0.65 and it is inelastic9. 0.00510. Chicken is a normal and a necessity good. 11. Beef and pork are substitutes to chicken.