Elexus Brooks- Bonus Assignment 1

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Elexus Brooks Bonus Assignment Chapter 14 review questions: 1. Provide an example of an investment. a. Purchase of stocks and bonds 2. What is the benefit of using present discounted value analysis? a. The benefit of using present discounted value analysis is that it helps compare payments that occur across different time periods. 3. When will an investment’s net present value be positive? Given its sign, should you invest in this project? a. An investment’s net present value will be positive when the present discounted value of its benefits outweighs the present discounted value of its costs. This means that the investment is worthwhile. 4. What advantage does net present value analysis have over the use of payback periods to evaluate investment decisions? a. Net present value analysis considers the present-day value costs and benefits of an investment. 5. What is the approximate relationship between an investment’s nominal interest rate and its real interest rate? a. An investment’s nominal interest rate expresses rates of return in raw currency values. Real interest rate expresses rates of return in terms of purchasing power. 6. How can expected value be used to evaluate risky investments? a. Expected values considers the uncertainty associated with an investment by using the probability that an investment payout will occur. 7. What is the value of insurance to a risk averse consumer? a. It benefits a risk averse consumer because it reduces the uncertainty associated with a given investment or situation. The reduced uncertainty increases the policyholder’s expected utility. 8. Why do we consider diversification a key function of insurance markets? a. Insurance companies insure consumers that the companies can rely on diversification to reduce their own risk and earn profits on their policies. Chapter 15 review questions: 1. Describe the two branches of general equilibrium analysis. a. Mechanics of market interactions and illustrates how various market features affect the size and direction of equilibrium effects in all these markets. b. Whether economy wide market equilibria are efficient or equitable

2. Social welfare functions combine the utility levels of everyone in society into a single index. List three types of social welfare functions and discuss what they mean. a. Utilitarian social welfare function- a mathematical function that computes society’s welfare as the sum of every individual’s welfare. b. Rawlsian social welfare function- a mathematical function that computes society’s welfare as the welfare of the worst-off individual. c. Egalitarian social welfare function- the belief that the ideal society is one in which everyone is equally well off 3. How do economists generally define efficiency in a market? a. Most economists consider a market’s efficiency using the concept of Pareto efficiency. A Pareto-efficient allocation is when you cannot reallocate the goods without making at least one individual worse off than before. 4. What are the three requirements of an efficient market? a. It must exhibit exchange, input, and output efficiency. 5. What can the Edgeworth box be used to examine? What does an Edgeworth box plot? a. The Edgeworth box can be used to examine market efficiency, including exchange, input, and output efficiency. It plots the allocation of two goods between two economic actors (consumers or firms). 6. What is the relationship between consumers’ marginal rates of substitution and the goods’ prices in an efficient market? How can this relationship be seen in an Edgeworth box? a. Two goods are allocated efficiently when the consumers’ marginal rates of substitution are equal to the ratio of the goods’ prices. A Pareto-efficient allocation can be found at the tangency between the two consumers’ indifference curves. 7. How does the consumption contract curve relate to Pareto efficiency? a. The contract curve is the line that shows the collection of all possible Pareto efficient allocations. 8. What does input efficiency imply about the relationship between the marginal rate of technical substitution and input prices? How can this relationship be seen in an Edgeworth box? a. An economy exhibits input efficiency when the two firms’ marginal rates of technical substitution equal the ratio of the wage rate to the capital rental rate. An efficient input allocation can be found at the tangency between the two firms’ isoquants. 9. How does the production contract curve relate to Pareto efficiency? a. The production contract curve is the line that shows the collection of all possible Pareto efficient input allocations.

10. How does the production possibilities frontier relate to the marginal rate of transformation? a. The marginal rate of transformation is the tradeoff between how much of one output must be given up gaining an additional unit of the other output. This is shown on the production possibilities frontier, which connects all possible Pareto efficient output combinations, as the slope of the production possibilities frontier at a given point. 11. What conditions are required for the First Welfare Theorem to hold? a. Any competitive equilibrium in a market must be Pareto optimal. b. All commodities are competitive in nature. c. Firms are price taker with no monopolist. 12. What does the Second Welfare Theorem predict? a. The second welfare theorem predicts that every Pareto efficient allocation is a general equilibrium outcome for some initial condition. Chapter 18 review questions: 1. Differentiate homo economicus and homo sapiens. a. Homo economicus- “economic man”, a regular human being that is able to solve any complicated economic problem, never make a mistake, and knows how to maximize anything b. Homo sapiens- a human being 2. Define overconfidence. a. A belief that one’s skill and judgement are better than they truly are, or that better outcomes are more likely to happen than their true probability 3. What does hyperbolic discounting lead consumers to prefer? a. Hyperbolic discounting leads consumers to prefer payoff in the present to future payoffs. 4. Why is time consistency important in economic models? a. A time inconsistent person’s actions differ across time which makes it difficult to analyze their behavior using traditional economic theory and models. 5. How does the endowment effect contradict aspect of conventional economic theory? a. The endowment effect states that an individual’s perception of the value of an object is altered by owning the good. Meaning the pain a person suffers from giving up the object is greater than the pleasure they experienced when receiving it. 6. What is the importance of the reference point in loss aversion?

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a. Nominal loss aversion refers to the instance when the individuals care about the nominal, not inflation adjusted, value of their loss. Loss aversion in the standard economic model assumes that consumers respond to real variables. 7. Describe one example of anchoring. a. A shopper who first looks at high end designer dresses may be more likely to pay a high price for the dress she eventually purchases than the person who first checks out the lower priced dresses. 8. How does mental accounting affect individuals’ consumption decisions? a. It affects how much a person spends and what they want to spend their money on. 9. How do economists attempt to account for altruism in economic models? a. By incorporating generosity into the utility function or allowing a person’s utility to depend on not only their own consumption but including the consumption of other people (such as children). 10. In the opinion of the authors of this textbook, what tends to happen to irrational or biased actors in the system? a. Irrational or biased actors tend to lose out to more rational, economically sound market actors. Resulting in people who exhibit economic biases to be weeded out of the market. 11. Lab experiments allow economists to test economic theory while holding all other variables constant. What are some downfalls of lab experiments? a. Individuals’ behaviors tend to change when they know they’re being watched by an experimenter. b. The stakes of economic games played in a lab are lower than those played in real life c. Participants are often asked to perform tasks in a lab that are foreign to them 12. Contrast natural and field experiments. What are some advantages of each? a. Natural experiments- a situation in which something happens that allows the researchers to learn about an economic question b. Field experiment- uses randomization, but is carried out in real world settings c. Advantages: both allow economists to examine economic actors in their natural environments, field experiments give economists a degree of control over the way the theory is tested

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