The Opportunity Cost - Essay Example

Define opportunity cost. What is the opportunity cost to you of taking s? Ans: Opportunity cost is the value of next best alternative sacrificed for any economic activity. The opportunity cost of taking any course is measurable when we can say what the options we have i.e. what we can do if we are not in the courses. We have to consider our ability to work. Then we have to find out which could be the best alternative for us if we had not joined the courses. Then the potential earring from that activity would be considered as the opportunity cost of taking courses. (See: Net MBA) What change must occur in an economy for its production possibility frontier to shift outward? Is it possible for an economys production possibilities frontier to shift inward? Explain. Production possibility frontier is the locus of different combinations of two commodities that a country can produce given its factor endowment and technology with the condition of full employment. The production possibility frontier is based on two constraints: the set of factor endowment and the technology. If there is an increase in either of the factor endowments or there is advancement in technology or both then the production possibility frontier (PPF) would shift outward. Normally the PPF does not shift inward. Theoretically PPF can shift inward if there is a decline in the factor endowment or a decline in technology or both. But in reality it is possible in the abnormal situations such as disaster or war when the endowment declines. See: Net MBA Explain the following statement: International trade can make some individuals worse off, even as it makes the country as a whole better off. The above statement can be explained by using an example. We consider a country having two sector agriculture and industry. Here we consider that the maximum of the industries are small scale and cottage industries. If the country engages itself in free trade then it would certainly be an exporter of agricultural product. The producers of agricultural product would enjoy better price in the global market. On the other hand the foreign industries are more cost efficient so they can supply industrial products at a lower price. The consumers of the domestic economy would be benefitted and the income of the country would also rise. But the small scale and the cottage industries would face foreign competition. That would hamper the interest of the owners of such industries. Hence the economy would face welfare gain while the owners of industry would be worse off. Explain the difference between absolute advantage and comparative advantage. Which is more important in determining trade patterns: absolute advantage or comparative advantage? In a two country (say A and B) two commodity (say X and Y) single factor (say labour: L) we can differentiate among absolute and comparative advantages. Absolute Advantage: Let us consider that in country i the amount of labor required to produce 1 unit of j is given as Lij. For all i=A,B and j=X,Y. Now if we find LAX < LBX and LAY > LBY we can say that country A enjoys absolute advantage in production of X and B in Y. If the countries are subject to perfect competition, full employment and perfect mobility of factors within the domestic boundary A should specialize completely in production of X and Bin Y. Free trade would be mutually beneficial. Comparative Advantage: Theory of comparative advantage emerged to answer the question “If one of the two countries enjoys absolute advantage over the other in both lies of production should there be any chance of mutually beneficial trade?” David Ricardo answered the question. According to him trade is mutually beneficial in such a situation if and only if there is a difference in opportunity cost of a commodity in terms of other between two countries. It can be explained as follows: If LAX/LAY < LBX/LBY then we can say: Opportunity cost of X in terms of Y in country A is lower than that in country B i.e. under the condition of full employment the increase in production of X by one unit requires a higher amount of Y sacrificed in country B than in country A. If the international price of X is PX and Y is PY then trade will be mutually beneficial if and only if: LAX/LAY< PX/PY < LBX/LBY. Comparative Advantage is a modified concept of Absolute Advantage. In the former the drawback of the latter has been recovered. Moreover in the international trade theory comparative advantage is known as the basis of trade. International Trade Theory and Policy by Stephen. M. Suranovic In the former Soviet Union, prices were set by a group of planners, and prices usually remained unchanged for several years. If a price system like this were introduced in the U.S. economy, what effect would it have on buyers, sellers, and market equilibrium? In a planned economy the market plays no role in the determination of economic variables. All are set by the planners. Soviet Russia was an example of such country. On the other hand a market economy is characterized by the existence of free market operation such as in USA. In American economy is the prices are set as rigid then the market forces can not change the price. If an excess demand situation arises the price adjustment would not take place. Hence there are three possibilities. 1. The excess demand situation is allowed to remain. 2. The producers may adopt the policy of quantity adjustment by producing more at the existing price. 3. The government can use its buffer stock to meet the excess demand. But on the other hand the consumers can do nothing. Rather they can make a shift in their demand towards any substitute good or they may change their consumption pattern. Similarly in the situation of excess supply the consumers have nothing to do. Rather, the producers can hold excess capacity in their hand or the government can intervene by purchasing the excess supply over demand to make a buffer stock. But it is difficult to say actually what will happen. Define cross-price elasticity of demand. What does it measure? What does it mean if the cross-price elasticity is negative? What does it mean if it is positive? Cross price elasticity is the degree of responsiveness of the demand for any commodity towards the change in the price of a related commodity. For example if we consider two commodities X and Y. XD is the demand for commodity X and PY is the price of commodity Y. The cross price elasticity of X in terms of Y can be expressed as EPY = % change in XD/ % change in PY If EPY < 0 we can say that X and Y are complementary goods as the price of Y and demand for X move in opposite direction If EPY=0 then there is no relation between X and Y as the change in price of Y does not affect the demand for X. If EPY>0 then X and Y are substitutes as the price of Y and demand for X move in the same direction. See: About.com: Economics How does a tax affect market activity? How does a tax affect the amount paid by buyers and the amount received by sellers as a result of a tax on a good? A tax always distorts the market situation. But the type of distortion created by the tax is dependent upon the type of the tax. Generally if a direct tax is imposed that hampers the interest of the taxed person but if the government imposes an indirect tax it affects others also. For example if the government imposes a sales tax or revenue tax or value added tax the taxed agent can transfer the burden of tax to others. For example if government imposes an excise duty on a product the producer can transfer a part of the tax to the consumers. But the part of tax that can be transferred to the consumer depends on the price elasticity of demand and supply. Higher the elasticity of demand the lower will be the part of tax that the seller can transfer to the buyers. For a perfectly elastic demand the producer has to bear the entire tax. On the other hand for an inelastic demand the producer has to bear the entire part of tax. On the other hand higher the elasticity of supply higher is the part of burden of tax that can be shifted to the consumers. If the supply is perfectly elastic the producer can shift the entire burden of tax to the consumers and vice versa. See: Knowledge Problem Using the graph below, answer the questions that follow. a. What was the equilibrium price and quantity in this market before the tax? b. What is the amount of the tax? c. How much of the tax will the buyers pay? d. How much of the tax will the sellers pay? e. How much will the buyer pay for the product after the tax is imposed? f. How much will the seller receive after the tax is imposed? g. As a result of the tax, what has happened to the level of market activity? Ans: a. Before imposition of tax equilibrium price is $8/unit and equilibrium quantity is 8000. b. The amount of tax is $3/unit c. The buyers will pay $1/unit d. The seller will pay $2/unit e. The price that the buyer has to pay after tax is $9/unit f. The seller receives $9/unit form the buyer but after the deduction of tax he receives $6/unit g. The equilibrium price rises from $8 to $9 per unit and equilibrium quantity declines from 8000 to 6000 units. References: 1. Net MBA: http://www.netmba.com/econ/micro/cost/opportunity/ 2. http://www.netmba.com/econ/micro/production/possibility/ 3. International Trade Theory and Policy: http://internationalecon.com/Trade/Tch40/T40-4.php 4. See: About.com: Economics: http://economics.about.com/cs/micfrohelp/a/cross_price_d.htm 5. Knowledge Problem: http://www.knowledgeproblem.com/archives/001733.html s Read More