1. ECON 100 Lecture 2
Wednesday, February 6

2. Announcements
I asked the Dean’s Office (Professor İnsan Tunalı) to raise the section capacity from 90 to 100 students.
Problem sessions are optional. They will start next week.
You can have a copy of the syllabus. (I have some left from Monday.)
Course webpage

3. From Monday’s lecture Remember the
‘How many workers would you lay off (işten çıkartma)?’ question from last lecture
The numbers were as follows…

4. Your recommendation (as the manager): I recommend continuing to employ ______ of the 196 workers in the company. Short justification for you decision: ______________

5. This survey question comes from a well known research article
A SCEPTIC’S* COMMENT ON THE STUDY OF ECONOMICS by Ariel Rubinstein
published in the March 2006 issue of The Economic Journal, a prestigious academic journal in economics.
* someone who habitually doubts accepted beliefs

6. Short summary of the article
A survey was carried out among two groups of undergraduate economics students and four groups of students in mathematics, law, philosophy and business administration. The main survey question involved a conflict between profit maximisation and the welfare of the workers who would be fired to achieve it. Significant differences were found between the choices of the groups.

7. Results

8. Results

9. Results

10. Results

11. Results

12. Results

13. Results

14. PhD students at MIT and Harvard

15. Our results…

16. 9 30 A.M. section results (N = 53)
Number of workers who will continue to be employed 65 3 6%
100 (profit max) 20
38%
144 22
42%
170 7
13%
196 1 2%
100%
Average layoff
69 workers

17. 11 00 A.M. section results (N = 76)
Number of workers who will continue to be employed 65 2 3%
100 (profit max) 35
46%
144 30
39%
170 5 7%
196 4 5%
100%
Average layoff
70 workers

18. Justifications: The manager should (ought to) maximize profits.
Non profit-maximizers:
Firing to many workers may damage the firm indirectly (bad image, cost of firing, etc) or in the long run
Very few respondents (15 out of 135) said we should also consider the welfare of the workers.

19. Economics start with the assumption that …
Now, today’s lecture
Economics start with the assumption that …

20. Economics start with the assumption that …
Rational people do activity x if and only if B(x) > C(x),
B(x) is the benefit of activity x (to the individual)
C(x) is the cost of activity (to the individual)
(pretty much ) Everything follows from this simple assumption.

21. How do we compute/find/represent the cost and benefit of an action
How do we compute/find/represent the cost and benefit of an action? When I say what is the cost of a can of Pepsi at Migros, the answer is clear. Some other situations, it may not be so. We will see more on this.

22. A detailed example: Should I iron my shirt?
[from Ben Bernanke and Robert Frank’s Principles of Economics, 2008]
You are going out with your girlfriend tonight, you have 20 minutes of time, your only clean shirt needs ironing!
Question. Should you iron the shirt?
Action x : “iron the shirt”
What will the rational “you” do in this situation?

23. Iron the shirt if benefit > cost

24. What is the benefit? What is the cost?
Benefit: You will look better. Cost: Exert effort, burn fingers? Cannot watch the end of the game/movie on the sofa. To compare cost and benefit we need to express them in a common unit of measurement. How to assign monetary values to B and C?

25. Measuring the benefit (in monetary units)
We conduct a mental auction to determine the maximum you are willing to pay someone else to iron the shirt for you.
Would you pay someone to iron your shirt for 1000 lira?
Would you pay someone to iron your shirt for 10 kuruş?
Suppose the answer to the 1st question is NO,
The answer to the 2nd question is YES.

26. We start with the high price of 1000 lira, each time you say NO, we decrease it by a small amount.
Suppose you say YES for the first time when we ask 3 lira for ironing the shirt for you.
Then we say that the benefit of this action (iron the shirt) is 3 lira for you.

27. This is a very important idea: Economists measure the benefit of a good or service to a person by the maximum amount of money that person is willing to pay to obtain that good or service. Willingness to pay (WTP)

28. Now, let’s measure the cost of ironing the shirt

29. Measuring the cost of the action (in monetary units)
Would you iron a shirt if we offered you 10 kuruş?
Would you iron a shirt if we offered you 1000 lira?
Suppose the answer to the 1st question is NO,
The answer to the 2nd question is YES.
Somewhere between these two extremes lies your reservation price,
which is defined as the minimum amount it would take you to do the job.

30. To find this number, (the minimum amount of money it would take you to do the job) we run the “mental” auction. We start with the low price of 10 kuruş, each time you say NO, we increase it by a small amount. Suppose you say YES for the first time when we offer you 5 lira. Then we say that the cost of the action (iron the shirt) is 5 lira.

31. B = 3 (max amount you are willing to pay), C = 5 (min amount you must be paid to to do job)
Apply the decision rule: action x = iron the shirt B(x) = 3 C(x) = 5. B(x) < C(x)  Don’t do it.

32. Let’s try something really confusing

33. Defining the cost of an action is not always straightforward!
The cost of something is what you give up to get it.

34. An example

35. Example : Should I go to the beach?
Your best friend says that next Saturday you should go to the beach. A day at the beach is worth to you 60 TL, the cost of food, transportation and entrance fee is 40 TL. On Saturday your initial plan was to work as an RA, in Prof Yılgör’s lab which pays 40 TL. You like the RA job so you would do it for free. If you are rational, will you go to the beach?

36. Version 2
The first part is the same. Go to the beach etc. But the alternative now is to wash dirty dishes at the main campus dining hall. This job also pays 40 TL. BUT you don’t like it and you would not do it for less than 20 TL. If you are rational, will you go to the beach?

37. Opportunity Cost
The value of the next-best alternative that must be forgone in order to undertake an activity.
Even using a good we already own is not free.
It could be sold or used for some other purpose. There is an opportunity cost.
Always ask “if I don’t do this, what is my best alternative”?

38. The Opportunity Cost question
You won a free ticket to see an Eric Clapton concert (which has no resale value).
Bob Dylan is performing on the same night and is your next-best alternative activity.
Tickets to see Dylan cost $40.
On any given day, you would be willing to pay up to $50 to see Dylan.
There are no other costs of seeing either performer.
Question : What is the opportunity cost of seeing Eric Clapton? Briefly explain your answer.
A. $0; B. $10 C. $40 D. $50