Department of Economic and Business Tutorial in Economics (Micro)

PS3 Fall 2017

Problem Set 3

1:
A. “Individual's’ behavior may change if they have insurance (e.g. riskier behavior)” √
C might be a consequence of moral hazard
People are changing behaviour because of this moral hazard.

2:
D. √
Department of Economic and Business Tutorial in Economics (Micro)
PS3 Fall 2017
A happens by definition
B happens because insurance companies don’t know who is healthy and who is unhealthy
C happens because ??

3: B. owners (investors) focus on long run, managers focus on rapid growth √

a. i. an indifference curve connects points on a graph representing different quantities of two goods,
points between which a consumer is indifferent (it gives the same amount of utility). the consumer has
Department of Economic and Business Tutorial in Economics (Micro)
PS3 Fall 2017
no preference for one combination or bundle of goods over a different combination on the same curve. √

ii. A constraint that shows the area of what a person can afford based on his income. (Fra PP: Constraints that
consumers face in their consumption as a result of limited incomes.)√

iii. Marginal utility: the change in total utility a person receives from consuming one additional unit of a
good or service. √

(Marginal means additional)

b. i. coffee: 20 per cup, tea: 10 per cup.√

ii. No. Because there is an area of the indifference curve below the budget constraint. The optimal point is where the
utility curve is tangent with the budget curve. √

iii.

Showing curve B:

MU_c = Marginal utility you get from coffee

MU_T = Marginal utility you get from tea

P_c = Price of coffee

P_t = Price of tea

Showing curve A:

iv.
Department of Economic and Business Tutorial in Economics (Micro)
PS3 Fall 2017

√
Department of Economic and Business Tutorial in Economics (Micro)
PS3 Fall 2017
c. Income effect: Higher wage → higher income → used to ”buy”(sacrifice) more leisure → to work
less (labour supply)

Worker’s purchasing power, or real income, will increase when the wage is higher. If leisure is a
normal good, the worker will like to consume more leisure.

Substitution effect: Wage increase → leisure is more expensive, it becomes more expensive not to
work → individuals want to work mere instead of having free time

When the wages rise, the opportunity cost of leisure rises (every hour spent on leisure time you will
be losing the opportunity to earn a wage that is higher now). As a result, workers will substitute
toward working more hours, holding constant the income effect.

The net effect of the wage increase is the sum of the substitution and income effect. In this case they
work in opposite directions. If the substitution effect is higher for one worker the worker will decide
to spend more hours working after the wage rate has increased. However, if the income effect is
higher for on worker he/she will choose to work less

It is because of specialization.

In the short run: The only way to produce more output is to hire more workers.

Because the capital cannot be changed in the short run, the marginal product of labor will eventually decrease
→ The law of diminishing returns.
Department of Economic and Business Tutorial in Economics (Micro)
PS3 Fall 2017
b.

B.

Both. You want an employer with a marginal product which should be at least the same as the average
product.
Marginal product: how much extra you get by hiring that extra guy

i. SAC1. Because the costs are lower when producing 4000 pizzas so it is most efficient.
ii. Larger because you need more capital to produce this amount. SAC2 is the cheapest size of
restaurant to produce this amount of pizzas.
iii. Because of fixed costs, the more you produce you can spread it out on fixed costs
Because of economies of scale:
Department of Economic and Business Tutorial in Economics (Micro)
PS3 Fall 2017
The medium size restaurant has higher fixed costs.
Firms may be able to purchase inputs at lower costs than their smaller competitors.

a. false.
b. false
c. True - His budget line is changing and he can afford less clothing because the price of clothes
has increased. The price of food has decreased and he can now afford more food.
d. False
e. False
√
Department of Economic and Business Tutorial in Economics (Micro)
PS3 Fall 2017
b. False. It is the other way around. When the marginal product of labour is rising, the marginal costs of
production are decreasing.

MPL goes up and implies MC to go down.

TC = FC + VC
MC = Marginal cost
TC: Total cost
FC: Fixed cost
VC: Variable cost
Q: Quantity
L: Labour
MPL: Marginal product of labour
c. True.
Accounting profits = Revenue - (hvad skal der stå her?) = Brutto
Economic profit = revenue - all costs (including depreciation, externalities) = Netto
Economic profits take into account opportunity cost