ECON1101 Tutorial 1: Decision Theory
1. Ivan has inherited his grandmother’s vintage car which he values at $45,000. He decides that he
might be willing to sell it so he posts it on carsales.com.au for $55,000. Samantha is interested
and willing to pay up to $72,000. Would Ivan and Samantha want to voluntarily engage in
trade? How much economic surplus is created for both of them as a result of this exchange?
What is the total economic surplus?
Solution to Q1
Yes, they can trade, AS LONG AS THEY CAN’T FIND BETTER DEALS; the price is above
Ivan’s cost and below Sam’s value.
Ivan’s surplus is just his revenue ($55,000), minus the cost of giving up the car ($45,000). Sam’s
surplus is her value ($72,000) minus the price ($55,000). So the total surplus is
$55, 000? $45, 000 + $72, 000? $55, 000 = $72, 000? $45, 000 = $27, 000.
2. It’s Sunday, and you are considering whether you should go out to dinner at a restaurant with
your friend. The meal is expected to cost you $40, and the restaurant charges a 10% surcharge
on Sundays. An Uber will cost you $10 to get there. You value the restaurant meal at $20.
You enjoy your friend’s company and are willing to pay $30 just to spend an evening with her.
If you did not go out to the restaurant, you would eat at home using groceries that cost you
$16. How much are the benefits and costs associated with going out to dinner with your friend?
Should you go out to dinner with your friend?
Solution to Q2
Cost of meal = $40 + 10% surcharge = $44
Total cost = meal cost+ uber cost = $44 + $10 = $54.
Total benefits = value of meal+ value of meeting friend = $20 + $30 = $50.
Adding up : Total profit = ?$4.
Costs of home = 0 or $16.
Benefits of home = WE DON’T KNOW.
Whether the cost of eating at home should be counted or not depends on whether we’ve already
bought the groceries, it may be a sunk cost. We can’t complete our analysis because we don’t
have enough information to value eating at home, and therefore we can’t compare it with the
restaurant meal.
3. It is a beautiful afternoon and you are considering taking a leisurely stroll through the park.
There are several other activities you had considered doing instead. The value you would have
received from each of the activities is provided in the table below.
Alternative activities Value
Streaming a movie $5
Taking a nap $8
Chatting with your best friend $13
Reading a new book $15
What is the opportunity cost to you of taking the stroll through the park?
Solution to Q3
Your favourite alternative option is reading a new book. This is the next best alternative, and
so represents your opportunity cost: $15.
4. Your niece is deciding whether or not to open a lemonade stand. She expects to sell 20 cups
of lemonade for $1 per cup. She has already made a sign that cost her $10 and will have $15
worth of additional costs for cups and lemonade mix if she decides to open the stand. If your
niece decides to open the lemonade stand, how much profit will she earn? Should she open the
lemonade stand? What kind of cost is the $10 spent on the lemonade stand sign?
Solution to Q3
What the profit depends on definitions.
Accountants include sunk costs, so the profit is
$1× 20 cups? $10 for a sign? $15 additional costs = ?$5.
Economists don’t include sunk costs. The sign is a sunk cost. The economic profit is
$1× 20 cups? $15 non-sunk costs = $5.
We can’t draw conclusions because we only know the material costs, not the opportunity costs.
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