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CH 1 SOLUTIONS TO END-OF-CHAPTER EXERCISES Answers to Thinking Critically Questions 1. When economists assume that people are rational, they assume that people use all available information as they act to achieve their goals, weighing the benefits and costs of each action and choosing an action only if the benefits outweigh the costs. By not changing jobs or retiring, these physicians have decided that economic and financial uncertainty have made the prospect of moving or retiring riskier and, therefore, moving or retiring has a higher cost than remaining in their current positions. 2. In developing an economic model, economists generally follow these five steps: 1. Decide on the assumptions to use in developing the model. 2. Formulate a testable hypothesis. 3. Use economic data to test the hypothesis. 4. Revise the model if it fails to explain well the economic data. 5. Retain the revised model to help answer similar economic questions in the future. The primary assumption you would probably make is that the physicians are interested in being financially stable when they do choose to retire. The article states that insurance reimbursement rates are declining, so your hypothesis might be that the decline in insurance reimbursement rates is directly related to the decline in the retirement rate of physicians. You would need to collect data on the changes in insurance reimbursements that doctors have received over several years as well as the actual retirement rate of doctors over those same years. You would also want to look at additional information, such as regulatory changes, medical malpractice insurance rates, and potential changes in the industry due to health care reform, and use this information to revise your model if the original model fails to explain well your original data. Once you have a model that does explain your economic data, you would retain that model and use it to help answer additional, similar questions in the future. 1.1 Three Key Economic Ideas (pages 60–64) Learning Objective: Explain these three key economic ideas: People are rational, people respond to incentives, and optimal decisions are made at the margin. Review Questions 1.1 Marginal analysis is the analysis of economic decisions at the margin of performing a particular economic activity–such the consumption or production of one additional unit of a 1 commodity–and comparing the marginal costs and benefits associated with such an activity. Rational economic agents will always make optimum decisions at the margin, where marginal benefits and costs may be traded off against one another. 1.2 Scarcity is the situation in which unlimited wants exceed the limited resources available to fulfill those wants. Economics is the study of the choices consumers, business managers, and government officials make to attain their goals. Scarcity is central to economics because scarcity requires people to make choices about how to use their resources to best fulfill their wants. Problems and Applications 1.3 As noted in the chapter, the economic incentive to banks is clear—it is less costly to put up with bank robberies than to take these additional security measures. 1.4 a. An effective grading system is important because students respond to economic incentives when deciding how to study a course. Such a system would ensure that students study the course appropriately and get the most out of it. b. Students would probably respond by working hard towards the end of the semester and by focusing on questions that are more likely to appear in the assessment. They would be less likely to read regularly through the term. c. A grading system which rewards students who read ahead of a class and who actively participate in classroom discussion could encourage students to participate. 1.5 Health insurance lessens the incentive for employees to improve or maintain their health, which increases medical expenses and, therefore, health insurance premiums paid by corporations and universities. The wellness programs corporations and universities use give employees an additional incentive to stay healthy, which reduces medical expenses and ultimately health insurance premiums. 1.6 a. Obese workers tend to suffer more medical problems than do people who are not overweight and so incur higher medical costs. The higher medical costs increase the health insurance premiums that firms must pay for the employer-provided health insurance, which raises the firm’s costs. In essence, obese workers, at the same wage, raise the costs of a firm more than workers who are not obese. Paying lower wages to obese workers helps firms to offset these higher costs. 2 b. Bhattacharya and Bundorf found that firms that provide health insurance pay lower

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