Skeleton notes #4

Question 1

Cost Benefit Analysis is the simple assumption that?

Answer 1

People weigh costs and benefits to come to a decision

Question 2

The economist ____________ popularized using cost benefit analysis to create ____________ about issues more controversial, such as _________

Answer 2

Gary Becker
Testable Hypothesis
going to school, committing crime, having kids, or discriminating against someone

Question 3

3 factors that go into cost benefit analysis

Answer 3

Cost
benefit
discount factor (or rate)

Question 4

Benefits equal the _______________ of a decision – the gains (or losses) of making a decision as compared to the default option.

Answer 4

Expected returns

Question 5

Costs = ________ + __________

__________ are typically the largest indirect costs of schooling.

Answer 5

Direct costs
indirect costs
Opportunity costs

Question 6

Since costs and benefits accrue over _____________________, we must also use a _____________________ so that future benefits can be compared to current costs

Answer 6

time
discount factor

Question 7

What are the 3 time related factors?

Answer 7

opportunity costs
time preferences
general economic conditions

Question 8

Higher δ (delta) shows preference towards more _______________ in that future _____________ are weighted more ________ in the current decision.

Answer 8

patience
benefits and costs
heavily

Question 9

What is the formula for δ (discount factor)?

What is the formula for r (discount rate)?

Answer 9

δ = 1/(1+r)

r = (1-δ)/δ

Question 10

If your discount rate is 10%, what is you discount factor (δ) ?

Answer 10

δ = 1/(1+r)
δ = 1/(1+0.1)
δ = 0.91

Question 11

If your discount factor is 0.9, what is you discount rate (r) ?

Answer 11

δ = 1 / (1+r)
r = (1 - δ ) / δ
r = (1 - 0.9 ) / 0.9
r = 0.11 = 11%

Question 12

The cost-benefit decision is represented by the __________, which is the summation of the _________ of all costs and benefits.

Answer 12

Net Present Value (npv)
present values

Question 13

If PV(B) _____ PV(C) or NPV _____ 0, then one would decide to do the investment.

Answer 13

> greater than
greater than

Question 14

Paula has a high school degree and is considering going to law school. If she does, she will spend $50,000 on tuition and books to get an undergraduate college education (t=0), $150,000 on tuition and books to get a law degree (t=1), and her law degree will benefit her $300,000 during the remainder of her work-life (t=2). Paula’s time preference for money is associated with a per-period interest rate of 10 percent. What is her net present value and should she invest in education?

Answer 14

δ = 1 / (1+0.1)
δ = 0.91

t=0: 0.91^0 (-50,000)
t=1: 0.91^1 (-150,000)
t=2: 0.91^2 (300,000)

NPV = t0 + t1 +t2

NPV = $66,430

Because are NPV is positive, she should invest in her education.

Question 15

What would a discount factor δ = 0.9 versus δ = 0.5 mean?

Answer 15

The lower the discount rate the lower willingness to invest