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Chapter 3 Optimization: Doing the Best You Can 1) Making choices by selecting the best feasible option, given the available information is referred to as: A) delegation. B) imposition. C) actualization. D) optimization. 2) Which of the following statements is true? A) It is easier for a person to optimize when he has less information. B) Optimization implies choosing the best option from a set of alternatives. C) People always successfully optimize given the limited information they have. D) Optimization is an easy process, and all economic agents are perfect optimizers. 3) Optimization can be achieved using either of two techniques of cost-benefit analysis. Which of the following correctly identifies the techniques? A) Optimization in levels and optimization in programs B) Optimization in levels and optimization in differences C) Optimization in programs and optimization in frames D) Optimization in differences and optimization in frames 4) Optimization in levels calculates: A) the total net benefits of different alternatives. B) only the benefits of an alternative and not the costs. C) only the costs of an alternative and not the benefits. D) the change in net benefits resulting from a shift from one alternative to another. 5) John has to choose between a camping holiday and a holiday in Las Vegas. If he evaluates the total net benefit of both alternatives before coming to a decision, he is using the technique of: A) marginal analysis. B) ordinal analysis. C) optimization in levels. D) optimization in differences. 6) Which of the following is NOT a step involved in optimization in levels? A) Calculating the total net benefit of each alternative B) Choosing the alternative with the highest net benefit C) Converting all costs and benefits into a common value of measurement D) Calculating the marginal consequences of moving between alternatives 7) Optimization in differences analyzes: A) the total net benefits of different alternatives. B) only the costs of an alternative and not the benefits. C) the total net benefits of the alternative that looks the most attractive. D) the change in the net benefits resulting from a shift from one alternative to another 1 Copyright © 2015 Pearson Education, Inc.

8) Gary has to decide between attending a two-day art workshop and a four-day art workshop. If he evaluates only the change in net benefit when he switches between the two options, he is using the technique of: A) ordinal analysis. B) comparative statics. C) optimization in levels. D) optimization in differences. 9) The techniques of optimization in levels and optimization in differences: A) cannot be used to compare the same set of alternatives. B) compare only the costs and ignore the benefits of the alternatives. C) provide identical answers when comparing the same set of alternatives. D) may provide different answers when comparing the same set of alternatives. 10) Which of the following statements identifies a difference between optimization in levels and optimization in differences? A) Optimization in levels compares only the costs of different alternatives, whereas optimization in differences compares only the benefits of different alternatives. B) Optimization in levels compares only the benefits from different alternatives, whereas optimization in differences compares only the costs of different alternatives. C) Optimization in levels calculates the net benefits of different alternatives, whereas optimization in differences calculates the change in net benefits when switching from one alternative to another. D) Optimization in levels calculates the change in net benefits when switching from one alternative to another, whereas optimization in differences calculates the net benefits of different alternatives. 11) Which of the following statements identifies a difference between optimization in levels and optimization in differences? A) In most cases, optimization in levels is faster and easier than optimization in differences. B) In many cases, optimization in differences is faster and easier than optimization in levels. C) Optimization in differences compares only the cost involved in different alternatives, whereas optimization in levels compares the net benefit of different alternatives. D) Optimization in differences compares the net benefit of different alternatives, whereas optimization in levels compares only the cost involved in different alternatives. 12) Both optimization in levels and optimization in differences: A) consider only the benefits from different alternatives. B) consider only the costs incurred in different alternatives. C) provide identical answers when comparing two alternatives. D) require the calculation of change in net benefits of switching from one alternative to another.

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13) Which of the following statements identifies a similarity between optimization in levels and optimization in differences? A) Both techniques consider only the costs of different alternatives. B) Both techniques consider only the total benefits of different alternatives. C) Both techniques evaluate the total net benefit of different alternatives to arrive at a decision. D) Both techniques require the conversion of all costs and benefits into a common unit of measurement. 14) Which of the following statements is true? A) Marginal analysis is a key component in the process of optimization in levels. B) Only direct costs are considered when the net benefits of the alternatives are calculated. C) In both the techniques of optimization, all costs have to be converted to the same unit of measurement. D) Optimization in levels calculates the change in net benefits when a person switches from one alternative to another. 15) To calculate the ________ of an alternative, an individual needs to estimate ________ of the alternative. A) marginal benefit; total cost B) ; total benefit C) opportunity cost; total benefit D) net benefit; both cost and benefit 16) Net benefits of an alternative equal: A) benefits minus costs. B) benefits divided by costs. C) the sum of benefits and costs. D) the product of benefits and costs. 17) If an alternative provides a benefit of $8 to an individual at a cost of $6, the net benefits of the alternative equal: A) $0.75. B) $2. C) $14. D) $48. 18) When optimizing in levels, if the ________ exceeds the ________, Project A is chosen over Project B. A) net benefits of Project A; net benefits of Project B B) total benefits of Project A; total benefits of Project B C) of Project A; s of Project B D) marginal benefits of Project B; marginal benefits of Project A 19) If the ________ minus the ________ is positive, Project A is chosen over Project B. A) cost of Project A; cost of Project B B) net benefit of Project B; net benefit of Project A C) net benefit of Project A; net benefit of Project B D) total benefit of Project B; total benefit of Project A 3 Copyright © 2015 Pearson Education, Inc.

20) If the net benefit of Project A is $5 and that of Project B is $8, switching from Project A to Project B: A) reduces the net benefit by $3. B) increases the net benefit by $3. C) increases the net benefit by $8. D) decreases the net benefit by $8. 21) If the net benefit of Project A is $20 and that of Project B is $15, switching from Project A to Project B: A) reduces the net benefit by $5. B) increases the net benefit by $5. C) reduces the net benefit by $15. D) increases the net benefit by $15. 22) If the net benefit of Project A is $10 and that of Project B is $12, which of the following statements is true? A) An individual can optimize by choosing Project A. B) An individual can optimize by choosing Project B. C) Switching from Project A to Project B reduces the net benefit by $2. D) Switching from Project A to Project B increases the net benefit by $1.2. 23) If Project A has a cost of $5 and provides a benefit of $10, and Project B has a cost of $2 and provides a benefit of $4, then switching from Project A to Project B: A) increases the net benefit by $3. B) decreases the net benefit by $3. C) increases the net benefit by $6. D) decreases the net benefit by $6. 24) If Project A has a cost of $2 and provides a benefit of $3, and Project B has a cost of $ 5 and provides a benefit of $8, which of the following statements is true? A) The net benefit of Project A is $5. B) An individual can optimize by choosing Project B. C) Project A has a higher net benefit than Project B. D) A shift from Project A to Project B increases the net benefit by $1. 25) If Project X has a cost of $6 and provides a benefit of $10, and Project Y has a cost of $25 and provides a benefit of $27, which of the following statements is true? A) An individual can optimize by choosing Project X. B) An individual can optimize by choosing Project Y. C) Switching from Project X to Project Y increases net benefit by $2. D) Switching from Project Y to Project X decreases net benefit by $2. 26) In most cases, optimization in differences is faster and easier than optimization in levels because: A) the former involves fewer steps to arrive at a conclusion. B) the former uses simpler arithmetic tools in comparison to the latter. C) the former focuses only on the benefits of an option, ignoring all calculations involving costs. D) the former only focuses on the key differences between options and ignores things in common. 4 Copyright © 2015 Pearson Education, Inc.

27) What is meant by the term "optimization"? What do economists usually believe about how individuals optimize? Choosing the best option from a set of feasible alternatives is referred to as optimization. Whatever choice a person faces, economists believe that he or she is likely to try to choose optimally. Economists don't assume that people always successfully choose the best feasible option, but that people try to do so and usually do a good job with whatever potentially limited information they have. This doesn't mean that people are always perfect calculators. Instead, economists believe that people's behavior is only approximated by optimization. In other words, they believe that an agent's actual choice will sometimes differ from that person's optimal choice. 28) What are the two techniques to optimization? How do the techniques differ? Optimization can be achieved using either of two techniques: optimization in levels or optimization in differences. Although both techniques provide identical results, there are differences between them. Optimization in levels analyzes the total net benefit of different alternatives, whereas optimization in differences analyzes the change in net benefits when switching from one alternative to another. Optimization in differences is often faster to implement than optimization in levels, because optimization in differences only focuses on the way alternatives differ. 29) What are the steps involved in optimization in levels? If option A has a cost of $5 and provides a benefit of $8, and option B has a cost of $10 and provides a benefit of $15, which of the two projects is optimal? The steps involved in optimization in levels are: a) Translate all costs and benefits into common units, like dollars. b) Calculate the total net benefit of each alternative. c) Pick the alternative with the highest net benefit. Total net benefit in option A = $(8 - 5) = $3 Total net benefit in option B = $(15 - 10) = $5 Because option B has a higher net benefit than option A, option B is the optimal choice of the two. 30) Assume that an individual has to choose between two options: buying a mobile phone, or buying an iPod. The expected cost of buying a phone is $700 and the expected benefit is $900. The expected cost of buying an iPod is $300, and the expected benefit is $600. How does the individual arrive at the optimal choice if he implements: a) optimization in levels? b) optimization in differences? a) The process of optimization in levels will require the comparison of net benefit of both the available options. This is shown as follows: Net benefit of buying a phone = $900 - $700 = $200. Net benefit of buying an iPod = $600 - $300 = $300. Because net benefit of an iPod exceeds the net benefit of a mobile phone, optimization in levels will suggest buying an iPod.

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b) The process of optimization in differences will require the estimation of the change in net benefit when an individual shifts from one alternative to another. This is shown as follows: Change in net benefit if the individual chooses to buy an iPod over a mobile phone = $300 $200 = $100, which is positive. On the other hand, change in net benefit if the individual chooses to buy a phone over an iPod = $200 - $300 = -$100, which is negative. Hence, optimization in differences will suggest buying an iPod. 31) How does optimization in levels differ from optimization in differences? Assume that the city council has to choose one among the following three alternatives: setting up a school, setting up a hospital, and setting up a playground. The estimates of expected cost and benefit of all three projects are shown in the following table. How does the city council arrive at the optimal choice if both the techniques of optimization are implemented? Do the results vary? Project Playground School Hospital

Cost ($) 15,000 20,000 50,000

Benefit ($) 30,000 50,000 75,000

The basic difference between the two techniques is that optimization in levels estimates the total net benefits of different alternatives before arriving at the optimum decision, whereas optimization in differences estimates the change in net benefits when the decision maker shifts from one alternative to another. Net benefit of setting up a school = $50,000 - $20,000 = $30,000 Net benefit of setting up a hospital = $75,000 - $50,000 = $25,000 Net benefit of setting up a playground = $30,000 - $15,000 = $15,000 Optimization in levels compares the net benefit of all alternatives before arriving at an optimum. The net benefit of setting up a school is the highest among all three alternatives, hence it is the optimum decision when optimizing in levels. Optimization in differences compares the change in net benefit when switching from an alternative to another. If the city council chooses to set up a school over setting up a playground, change in net benefit = $30,000 - $15,000 = $15,000 If the city council chooses to build a hospital over setting up a playground, change in net benefit = $25,000 - $15,000 = $10,000. Therefore, setting up a playground is not the optimum choice. Instead of a hospital, if a school is built, change in net benefit = $30,000 - $25,000 = $5,000. Because the change in net benefit when switching from hospital to school is positive, setting up a school is a better option between the two. Hence, setting up a school is the optimum decision among the three alternatives when optimizing in differences. We can see that both the techniques suggest that building a school is the optimum choice. 6 Copyright © 2015 Pearson Education, Inc.

1) To carry out an optimization analysis: A) different types of costs are measured in different units. B) only direct costs incurred in a project are to be estimated. C) only indirect costs incurred in a project are to be estimated. D) all costs are required to be converted to a same unit of measurement. 2) If the opportunity cost of time is $20 per hour, and an individual spends 20 hours in commuting every month, his opportunity cost of commute is: A) $1 per month. B) $20 per month. C) $200 per month. D) $400 per month. 3) If the opportunity cost of time is ________, and an individual spends ________ commuting every month, his opportunity cost of commute is $100 every month. A) $5 per hour; 10 hours B) $8 per hour; 20 hours C) 10 per hour; 10 hours D) $12 per hour; 5 hours 4) If an individual's opportunity cost of commute is $300 per month and his monthly commuting time is 60 hours, his opportunity cost of time is: A) $5 per hour. B) $10 per hour. C) $30 per hour. D) $60 per hour. 5) Among a set of alternatives with the same benefits, an individual is said to optimize if she chooses an alternative that: A) has the lowest total cost. B) has the highest total cost. C) has the highest indirect cost. D) has the lowest opportunity cost. 6) Among a set of alternatives with the same total costs, an individual is said to optimize if she chooses an alternative that has the: A) highest total benefit. B) highest risk. C) lowest opportunity costs. D) highest net costs. 7) An individual pays $100 every month as rent for an apartment, and his monthly opportunity cost of commuting from the apartment to his place of work is $40. Which of the following statements is then true? A) The direct cost of renting the apartment is $140. B) The indirect cost of renting the apartment is $140. C) The direct cost of renting the apartment is $40, whereas the indirect cost of renting the apartment is $100. D) The direct cost of renting the apartment is $100, whereas the indirect cost of renting the apartment is $40. 7 Copyright © 2015 Pearson Education, Inc.

Ryan wants to rent an apartment. The following table shows the monthly rent of five apartments and the monthly commuting time to work from each apartment. Ryan's opportunity cost of time is $15 per hour.

Apartment 1 2 3 4 5

Commuting Time (hours/month) 40 20 10 4 1

Rent ($/month) 1,500 1,750 2,000 2,210 2,250

8) Refer to the table above. What is the total cost incurred per month if Ryan rents Apartment 3? A) $2,000 B) $2,050 C) $2,150 D) $2,270 9) Refer to the table above. What is the total cost incurred per month if Ryan rents Apartment 5? A) $2,150 B) $2,270 C) $2,400 D) $2,265 10) Refer to the table above. What is the opportunity cost of commute per month to work if Ryan rents Apartment 2? A) $20 B) $150 C) $200 D) $300 11) Refer to the table above. The total cost per month is the highest if Apartment ________ is rented. A) 2 B) 3 C) 4 D) 5 12) Refer to the table above. The total cost per month is the lowest if Ryan chooses to rent Apartment ________. A) 1 B) 2 C) 3 D) 4 8 Copyright © 2015 Pearson Education, Inc.

13) Refer to the table above. If the opportunity cost of time increases to $60 per hour, renting which apartment will minimize Ryan's total cost every month? A) 2 B) 3 C) 4 D) 5 14) Refer to the table above. If the opportunity cost of time increases to $60 per hour, renting which apartment will turn out to be the most expensive every month? A) 1 B) 2 C) 3 D) 4 15) The analysis of economic outcomes before and after some economic variable is changed is referred to as: A) Pareto analysis. B) marginal study. C) cardinal research. D) comparative statics. 16) Which of the following statements is true? A) Marginal analysis is a key tool used while optimizing in levels. B) Comparative statics is a tool that can be used in both optimization in levels and optimization in differences. C) Marginal analysis is the comparison of economic outcomes before and after some economic variable is changed. D) Comparative statics involves calculating the incremental cost of moving from one alternative to the next best alternative. 17) The analysis of how a customer's tastes for cars will change when his wealth triples is under the scope of: A) ordinal study. B) marginal research. C) Pareto analysis. D) comparative statics. 18) Which of the following is an example of comparative statics? A) The estimation of the quantity demanded of a good when its price is $5 B) The estimation of the demand for a particular good when consumer income is $10 C) The estimation of the ideal number of workers a firm should hire when wage rate is $20 per hour D) The estimation of the supply of a good when the wage rate of labor changes from $30 to $10 per hour

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19) An individual rents an apartment for $200 per month. His monthly opportunity cost of commuting to work from this apartment is $50. After a year, he moves to an apartment closer to his place of work, but pays $250 as rent. Compared to the initial situation, after a year: A) his direct cost of renting the apartment increases, while the indirect cost of re...