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    Managerial Economics: Example Problems

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    1. It is well documented in scientific research that smoking is harmful to health. Smokers have higher incidences of coronary disease, cancer, and other catastrophic illnesses. Knowing this, about 30 percent of young people begin smoking, and about 25 percent of the U.S. population smokes. Are the people who choose to smoke irrational?
    What do you think of the argument that we should ban smoking in order to protect these people from themselves?

    2. Are the following statements normative or positive? If a statement is normative, change it to a positive statement.
    a. The government should provide free tuition to all college students.
    b. An effective way to increase the skills of the work force is to provide free tuition to all college students.
    c. The government must provide job training if we are to compete with other countries.

    3. In the New York Times Magazine in 1970, Milton Friedman, a Nobel Prize-winning economist, argued that "the social responsibility of business is to increase profits." How would Friedman's argument fit with the basic economic model that people behave in ways that they believe are in their best self-interest?

    4. Use economics to explain why diamonds are more expensive than water, when water is necessary for survival and diamonds are not.

    5. During China's Cultural Revolution in the late 1960s and early 1970s, highly educated people were forced to
    move to farms and work in the fields. Some were common laborers for eight or more years. What does this policy say about specialization and the PPC? Would you predict that the policy would lead to an increase in output?

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    Solution Preview

    1. About 25% of the US population smokes, but that does not mean that they are irrational. Every person takes the decision that he or she thinks is the best for them. When we say that smoking is irrational we are imposing a normative structure to the act of smoking: it may be irrational for me to smoke, but not necessarily for someone who smokes!

    A positive way to judge rationality is to ask people to rank different activities and then see if the ranking is consistent. Rationality is therefore, largely reduced to a set consistency conditions. It requires behavior to be consistent with some preference ordering, and as long as such ordering is there, the agent is said to be consistent.

    Getting back to the smokers, all we know is that they have higher incidences of coronary diseases, cancer, and other catastrophic illnesses, and the smokers know that too. But, the question then arises is how much more? Is it 1% higher, 20% higher, or some other number? Are they twice as likely to die from a coronary disease, thrice as likely, or are the odds significantly higher? Maybe the odds are not high enough for the smokers to change their preference ordering and quit smoking.

    If ...

    Solution Summary

    Provides steps necessary to answer each of the questions.