Business Economics: Opportunity Costs and Dynamic Comparative Advantage - Assignment Example

BUSINESS ECONOMICS Ans According to Opportunity costs can be defined as the value of the next best alternative foregone (Business Economics StudyGuide, Pp. 13). The opportunity cost of going on the ski trip is the sum of: loss of income from the weekend job $120 The cost of travelling and living away from home $350 the cost of ski hire $60 The cost of food $40 the time (lost) to study 8 hours Total = $570 and 8 hours Explanation: Since we have already decided to go skiing, the money cost involved here can be calculated as follows: Travel and accommodation $350 Ski hire $60 Food $40 Total $450 This tells us the exact amount of money which we shall have to incur in order to go skiing. But while calculating opportunity cost, we must determine the cost of the next best alternative foregone1. Suppose we decided to work during the weekend we would have been able to earn $ 120 and study for 8 hours and save the amount spent on accommodation and food2. Now, by deciding to go skiing during the weekend, we are foregoing the amount of money we might have earned from the weekend job as well as the time spent on studying. The opportunity cost of going skiing then, is the value of what we would have gained if we worked instead of skiing. If we worked, we wouldnt have to pay for the skiing trip, food or other related expenditure and instead earn $120 and some extra time for studying (here, 8 hours). The opportunity cost hence, for skiing would be: $570 and 8 hours Note: This excludes the amount spent on travelling, since if we chose to work, we would still have to incur travelling expenditure (if not on food and rent). Since the amount of expenditure incurred on travelling is not mentioned separately, it could not be included here. Ans.2 The law of comparative advantage, in economics, refers to: "A situation in which an individual, group or a country can produce one good at a lower opportunity cost than another individual, group or country" (Mankiw, N. G., Taylor, M. P., 2006) Thus, on the basis of the above definition, one may safely conclude, that the key factor which gives an individual, a group or a country a comparative advantage, is the ability to produce something at the lowest opportunity cost (Hackett, 1998, Pp.401). Example: The law of comparative advantage states that any individual, group or a nation which has the ability to produce goods at lower opportunity cost must specialize in that particular good, For instance, if a lawyer has better typing skills than his/her secretary or assistant, they must continue to specialize in law, rather than doing the typing job themselves, since, the opportunity cost of time spent on typing is much higher than the time invested in specializing in law, which is their primary profession (Archibugi, Nijkamp, 1989, Pp.84). Dynamic Comparative Advantage “Dynamic comparative advantage refers to shifts in a systems competitiveness that occur over time because of changes in three categories of economic parameters-long-run world prices of tradable outputs and inputs, social opportunity costs of domestic factors of production (labor, capital, and land), and production technologies used in farming or marketing. Together, these three parameters determine social profitability and comparative advantage” (Zysman, 1984, Pp.39) In general, individuals, groups or nations are said to have a comparative advantage, in the production of goods which are intensive in the use of factors in which they are profusely gifted. For instance, China has abundant and cheap labor, and hence has a comparative advantage in selling low cost products to Australia; similarly Australia has abundant natural resources and sells it to China. Ans. 3 a. If the price of a DVD rises: The law of demand states that all other things remaining constant, if the price of a product goes up the demand for the same declines, and vice versa. Hence if the price of a product is increased its demand decreases, since the opportunity cost also increases with the rise in price. Hence in order to buy the DVD whose price is risen from say, 10 to 20, the consumers will have to forego some other product, to make up for the additional 10 unit increase in the price. Hence, consumers are more likely to opt for lower priced substitutes thereby leading to the decrease in demand for the DVDs. The same can be explained as follows: (There exists an inverse relationship between price and quantity demanded, i.e. higher the price, lower the quantity demanded). P1 P2 P3 Q1 Q2 Q3 P = Price, Q = Quantity (b) The supply of DVD players increases The law of supply indicates a positive relationship between the price of a product and the quantity supplied. As price rises, the supply rises, and vice versa. From a consumers point of view, the demand for a product tends to fall with the rise in price, but from the producers perspective, the price of the product represents revenue, which acts as an incentive, hence, higher the price, greater the supply. (c) Consumer’s income increases The income of the consumers represents their purchasing power. Hence higher the income higher their purchasing power. An increase in consumers income would lead them to buy more of normal goods and less of inferior goods; hence the quantity of the DVD players sold is likely to increase with the increase in consumers income (assuming that there are no substitutes available) (Moschandreas, 2000 Pp.117). The presence of a large number of substitutes available in the market may significantly impact the demand for the given product, since the consumer has a large variety of goods to choose from and hence such an assumption. (d) The wage rate of workers who produce DVD players increases If the wages of the workers increases it would lead to a rise in cost of production of the DVD players which in turn would lead to a higher selling price. Hence an increase in workers’ wages would ultimately lead to highly priced DVD players. Any rise in price, as discussed above, would lead to a fall in demand (law of demand). The quantity demanded would hence fall (Assuming that all other things remaining constant). Ans. 4 Price of a product plays a major role in a market economy in influencing the consumers to opt for a given product. Various laws help in understanding such a relationship between the price of the product and the quantity demanded, such as law of demand and supply etc and Price elasticity of demand is one of such vital laws that govern the decision making process. However, it offers relatively more knowledge as compared to the simple law of demand and supply in the sense that it helps the producers in calculating the extent of changes in price on the demand for their goods. The price elasticity of demand refers to “the measurement of the degree of responsiveness of the quantity demanded (or supplied) of a good to changes in its price” (Business Economics Study Guide, Pp.30). Price elasticity of demand = Percentage change in quantity demanded Percentage change in price For example, the NESTLE Australia, which is contemplating an increase in price of the Milo food drink, with a view to increase their revenue. If a 10% change in the price of the product causes the amount of the product purchased to fall by 20% which is double the change in price. Since the elasticity is greater than the price range of interest, it is quite apparent that the price rise would in fact lead to a fall in revenue and hence it would be unwise to do so. This indicates that the price elasticity for Milo is elastic, since it is greater than 1, meaning thereby that any increase in price would lead to a simultaneous fall in quantity demanded and hence the revenue (Boyes, Melvin, 2008,Pp. 86). The graph hence would indicate a horizontal demand curve as shown below: Price 0 Quantity Demanded Ans.5 When a consumer chooses the combination of goods and services to buy, they are trying to satisfy their tastes and preferences by maximizing their "utility" subject to the income constraint. The term utility refers to the level of satisfaction achieved by the consumer (Business Economics Study Guide, pp. 44). In order to ascertain the effect of fall in prices of a normal good on the demand for the same, the term normal good must be defined. According to Mankiw (1998, Pp. 64) a normal good is defined as: “a good for which other things remaining equal, an increase in income leads to an increase in quantity demanded". If the price of a normal good falls, the quantity demanded increases, other things remaining constant (i.e., consumer’s income, price of substitute goods etc) References: Archibugi, F., Nijkamp, P., (1989). Economy and Ecology: Towards Sustainable Development, Springer, Pp.84 Boyes, W. J., Melvin, M., (2008). Business Economics, Cengage Learning, Pp. 86 Business Economics Study Guide, Faculty of Business Hackett, S. C., (1998). Environmental and Natural Resources: Theory, Policy and the Sustainable Society, M.E. Sharpe Publishers, Pp. 401 Mankiw, N. G., Taylor, M. P., (2006). Economics, Cengage Learning. Moschandreas, M., (2000). Business Economics, Cengage Learning, Pp.117 Ozawa, T., (2005). Instituitions, Industrial Upgrading, and Economic Performance in Japan, Edward Elgar Publishing, Pp.150 Zysman, J., (1984). Governments, Markets, and Growth: Financial Systems and the Politics of Industrial Change, Cornell University Press, Pp. 39 Appendices: Figure 1: Stages of development, changing factor proportions, and dynamic comparative advantage Source: Ozawa, T., (2005). Instituitions, Industrial Upgrading, and Economic Performance in Japan, Edward Elgar Publishing, Pp.150 Read More