Seminar 1 – Problem sets

Problem 1

Tom wants to start a new hamburger restaurant in Barcelona. To run the restaurant, he

can either manage the restaurant himself or hire a manager who would earn "x" Euro

per year.

Suppose that Tom's yearly gross profit from the hamburger restaurant, before paying

the manager's salary, would be 35.000 Euro and that he can earn 40.000 Euro per year

in an outside job.

For what salary of the manager would Tom decide to hire the manager to run the

restaurant instead of doing the job himself? Why?

If Tom decides to manage the restaurant himself, he would be refusing

to earn 40.000€ per year in the outside job. Comparing this amount of

money with the one that he can earn applying himself the restaurant

management, we can say that the option of managing the hamburger

restaurant creates a opportunity cost of 5.000€.

Having seen this, we can say that is obvious that Tom has to hire a

manager. The salary of this manager has to be, as high, a little bit less

than 40.000€.

If he hires a manager that earns, for example 39.000€ each year, Tom

is winning money because if he works in the own restaurant, he will

earn only 35.000€ but if he applies for another job he will earn 35.000€

(from the restaurant) + 40.000€ (from the other job) = 75.000€.

Otherwise, all the costs of choosing this option will only result the

salary of the manager that is 39.000€ each year. If we do the rest,

(75.000€ - 39.000€) we conclude that Tom is earning 36.000€ that is

more than 35.000€.

In conclusion: He has to catch the outside job if he is able to contract

someone who earns, as high, a little bit less (1€ less) than 40.000€. If

he can’t find any person who can does the manager job for less than

40.000€ his better option is to manage the restaurant himself.

Problem 2

Albert Einstein once stated the follwing: "Only two things are infinite. The Universe and

human stupidity and I'm not so sure about the first ..."

How do you interpret this statement based on the model of the rational economic

agent? Give an example of how making a stupid decision can be rational.

I think that this sentence is an example of the rationality that all the

humans have acquired during the recent time. In this case we can say

that most of the answers and choices that we do are irrational because

they are instinctive.

We can explain the case that is presented to us when we face the

“Asymmetric Value Function”. Humans make decisions irrational only

because they strongly prefer avoiding losses than acquiring gains.

One case would be the assuming of a sunk cost and counting it as

relevant. For example, some companies can consider the following:

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Seminar 1 – Problem sets

Problem 1 Tom wants to start a new hamburger restaurant in Barcelona. To run the restaurant, he can either manage the restaurant himself or hire a manager who would earn "x" Euro per year. Suppose that Tom's yearly gross profit from the hamburger restaurant, before paying the manager's salary, would be 35.000 Euro and that he can earn 40.000 Euro per year in an outside job. For what salary of the manager would Tom decide to hire the manager to run the restaurant instead of doing the job himself? Why?

If Tom decides to manage the restaurant himself, he would be refusing to earn 40.000€ per year in the outside job. Comparing this amount of money with the one that he can earn applying himself the restaurant management, we can say that the option of managing the hamburger restaurant creates a opportunity cost of 5.000€. Having seen this, we can say that is obvious that Tom has to hire a manager. The salary of this manager has to be, as high, a little bit less than 40.000€. If he hires a manager that earns, for example 39.000€ each year, Tom is winning money because if he works in the own restaurant, he will earn only 35.000€ but if he applies for another job he will earn 35.000€ (from the restaurant) + 40.000€ (from the other job) = 75.000€. Otherwise, all the costs of choosing this option will only result the salary of the manager that is 39.000€ each year. If we do the rest, (75.000€ - 39.000€) we conclude that Tom is earning 36.000€ that is more than 35.000€.

In conclusion: He has to catch the outside job if he is able to contract someone who earns, as high, a little bit less (1€ less) than 40.000€. If he can’t find any person who can does the manager job for less than 40.000€ his better option is to manage the restaurant himself.

Problem 2 Albert Einstein once stated the follwing: "Only two things are infinite. The Universe and human stupidity and I'm not so sure about the first ..." How do you interpret this statement based on the model of the rational economic agent? Give an example of how making a stupid decision can be rational.

I think that this sentence is an example of the rationality that all the humans have acquired during the recent time. In this case we can say that most of the answers and choices that we do are irrational because they are instinctive. We can explain the case that is presented to us when we face the “Asymmetric Value Function”. Humans make decisions irrational only because they strongly prefer avoiding losses than acquiring gains. One case would be the assuming of a sunk cost and counting it as relevant. For example, some companies can consider the following:

“We have invested 10 million euro in some investment”. The no- rational answer will be: “We have to continue the investment because if we don’t do it, we will lose all the money invested until now”. Of course, this is not rational, like not considering the opportunity costs that you have by choosing one investment rather another.

However, sometimes “stupid” decisions can be rational. For example, if you are waiting a bus in the bus station and you’ve waited 20 minutes you don’t have to consider this 20 minutes to choose the now best alternative. In other words, you don’t have to wait more time “because you’ve already waited 20 minutes”. Also, if you know that the bus passes every 30 minutes, for example, you have to take in consideration these 20 minutes as information, but you are contradicting the “classic economic view” because you’re considering a sunk cost.

Problem 3 On 26 April, the city council of "Cullera" decided not to cancel a fireworks show of a celebration, despite the highest level of risk alerts for the forest announced by the Emergency Coordination Center. The show ended up burning more than three hectares of forest at "Mount Cullera". 1.a) Why was there uncertainty in making the decision to cancel or not to cancel the fireworks show? 1.b) In defence of his decision, the mayor declared "If I knew what was going to happen, I would not have done it." Is this an optimal reasoning a priori or a posteriori? Why? 1.c) Discuss why it may be justified to punish the conduct of the mayor independent of whether the fire had occurred or not.

1.a) Because they have the uncertainty of the risk. In the one hand they have the information of the risk they have. In the other, they have the investment realised and the call they have done to citizens to attend it. In the view of ex-post (when the payoff is realised) we can say that they have done it wrong because it went to bad. Otherwise, in the view of ex-ante, is possible that the percentage of the risk was low.

1.b) This is an optimal reason a priori because before passing it they are have a high uncertainly. They have to evaluate the probability ex- ante and decide if the risk was high or low. He has to get more information about the risk of continue with the firework show to know in what percentage will the fire succeeded.

1.c) The mayor can be punished because in a uncertainty situation we have to search the best convention of information and minimal risk. In other words, he has the obligation on going with the optimal point of information and risk that can minimise the cost of the worst situation. If you have enough information, for example, to not place the firework

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