# Accounting for Prudent Choice:Exercises & Problems

EXERCISES AND PROBLEMS
1. Keep a record of your own accounts for one week. Take stock at the beginning of the week and record everything you spend and receive. Calculate the balance at the end of the week. Account for any transfers you get from parents or bank loans. How much did you save or dissave?
2. From a microeconomic perspective, every action has a cost. Explain why.
3. Paul's salary check for the last two weeks of September was late in coming. How should he account for the delay (a) on his income statement and (b) on his balance sheet. [Hint: How would you record income that's earned but not yet received? Is someone indebted to Paul?]
4. Bayla asks Paul to go with her to the new restaurant in town. "It's cheap," she says. "Seven bucks for spaghetti. The line's a little long, though. It takes about 45 minutes to get in." Paul declines, saying, "The price is too high." Explain his response, using the concept of opportunity costs.
5. Your friend says: "My dad figures that every class I skip costs my family about \$40. But he's wrong! My tuition and fees are all paid for at this point. So, economically, it costs nothing if I choose to skip a class." Evaluate this statement from an economic point of view.
6. A larger percentage of young people from well-to-do families go to college than young people from poor but working families. (This seems to have something to do with the costs of attending college, including the cost of foregoing full-time employment.) The working poor, of course, pay taxes to the state. The state university proposes to raise tuition; the alternative is for the state government to raise taxes and then channel the money to the University. A cry goes up that a tuition increase will hurt the poor. Will it?
7. Here are the statistics for defense and non-defense expenditures for the United States, 1939-1947 (all measured in billions of dollars at 1982 prices):
- Defense expendituresNon-defense expenditures
1939 \$8.5 \$687.6
1940 \$11.6 \$725.4
1941 \$43.9 \$774.9
1942 \$163.1 \$804.3
1943 \$418.6 \$745.6
1944 \$163.0 \$816.8
1945 \$43.9 \$833.2
1946 \$11.6 \$866.9
1947 \$8.5 \$952.7

Plot on a graph the Defense curve and the Non-defense curve. What appears to have happened to the production possibilities curve of the United States during the Second World War? (The U.S. was in the war from December 1941 until August 1945.)
8. A hurricane strikes and destroys much of Robinson Crusoe's stockade, his fences for herding sheep, and other precious equipment. What happens to his production possibilities curve? Graph the change with food on the vertical axis and defense on the horizontal axis.

ESSAY AND DISCUSSION QUESTIONS

9. Is sunlight a scarce resource? (Hint: Is it limited in supply?) Is giving one more person the protection of the United States Army a scarce good, once the Army is in existence?
10. Paul tells Rodney that he has decided not to buy the \$1200 guitar because it is too expensive. State his decision in economic terms.
11. Rodney: I don't know about this prudent choice stuff. I sure didn't sit down and weigh the pros and cons before I decided to come to college.
Paul: Me either. But there seem to be some good economic reasons for coming.
A. How might their opportunity costs differ? Assume that Paul comes from a well-to-do and Rodney from a poor family.
B. Consider Rodney's skepticism towards the notion that he made a prudent choice. What arguments would economists make to convince him?
12. Economists stress the analogy between the choices made by individuals and the choices made by societies (cities or nations, for example). Explain this analogy, using the Robinson Crusoe example and the concept of the production possibilities curve. In which ways is the analogy imperfect? (Think, for example, of making a decision in a society, such as a decision to go to war or a decision to invest more money in preschool education. How is it similar to or different from the decision of an individual?)
13. Assume that a machine is invented (such as a fertilizer spreader) that makes it easier to produce food but that does not make it any easier to produce defense goods. Draw the society's production possibilities curves before and after the invention of the machine. Where does the new curve start along the defense axis? Where is the new curve relative to the old?
14. Paul changes his mind and decides to buy the \$1200 guitar, but does not do anything to get the cash for it. Rodney says: "You don't have any money in your savings account. How can you buy the guitar if you don't have any savings!" How should Paul respond? (Hint: Are savings always in the form of an addition to savings accounts?)

1. Society may decide that going to college is a right. But this involves a choice, too. The money the society spends on Maria's education could be spent on something else. And Maria herself could have worked, or gone on vacation, instead of going to college. Since college education entails these costs (for individuals and for society), it must be considered an economic choice.

2. First of all, the opportunity cost of a year of college is the dollar value of the goods and services the student (or her parents) forgo in order to pay for tuition, room, books, board, travel back and forth to home, and the like. If you pay tuition you cannot use that money to buy clothing or food or entertainment. On the other hand, not all such costs represent opportunities forgone, because Paul has to eat and use a room whether he goes to college or not. So to get the net opportunity cost the cost of home-produced room and board needs to be subtracted from the college bill, as something that has to be paid anyway. As we've seen, though, to derive the opportunity cost of a given choice we have to look closely at the value of the next-best opportunity. You cannot go to college and, at the same time, take a world tour or work at your uncle's garage. Suppose the next-best alternative for Rodney is to take a job to help his mother over hard times. The opportunity cost of his choice to go to college is then easy to measure. It is the income he could have earned. Accordingly, the total cost of Rodney's college education is the direct cost plus the wages he forgoes.

3. The full cost of the meal includes the cost of standing in line. Apparently Paul thinks he would give up a lot by standing in line for 45 minutes. The benefits forgone - like the benefits from studying for his history exam - would make it an expensive meal for him. Someone with time to waste would see the cost as lower.

4. The car, you say? No, it's her brain. With a college education she will earn on the order of \$500,000 more than a high-school graduate over her lifetime. That's why economists call the value of our knowledge and skills "human capital." Unfortunately, the value of the human brain is hardly ever included in a balance sheet.

5. Paul, your savings are the difference between income and expenses. Your savings would be equal to your savings deposit at the bank only if you chose to hold all your assets in a savings account.

6. The suit is an investment, because it will be used for more than a year.

7. What Paul means is that as soon as he drives the car off the lot, it depreciates, which is true. But depreciation, in accounting terms, is an expense, not part of the investment. True, in this case the expense comes pretty quickly after the investment. But for accounting and economic purposes the reshuffling of wealth (a matter for balance sheets) should be kept separate from the expenses incurred from using the equipment (a matter for income statements).

8. For a company the "bottom line" is what counts, profit. A company will be most interested in what is left after the payment of corporate income taxes, so its in after tax profits that it "makes money".

9. It means that resources are going unused, that there are unemployed workers, idle factories, and vacant offices.