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Opportunity Cost and Decision Making

Explain the concept of opportunity cost and reflect an occasion in recent weeks where the concept ofopportunity cost applied to you.
b. Explain, with the use of demand and supply diagrams, the effect of the following events on the market for solar panels:
i. The price of solar panels has fallen to below the market equilibrium price.
ii. The price of electricity for an average household has increased by 50 percent

Grannie Mae woke up feeling very excited because her favourite Granny Smith apples have decreased in price due to a very good harvest. Due to her limited food budget she usually bought 1 kilo of apples per week. This time she is going to go to her favourite fruit store and buy three kilos at the lower price. On her way back home she passed a shop selling the latest walking frame and they had the one which all her friends are using. Granny Mae, who was thinking of buying a regular walking stick, decided instead to buy the walking frame. When purchasing the frame, the store attendant told her that the frames are very popular and they have sold quite a few of them this month.

Two weeks passed and granny Mae was very happy with the walking frame and is now thinking of going to visit
her sister in Queensland. She rang her sister and told her that she will visit her next month because the government is increasing her pension.
a. Identify the concept of the law of demand, from the paragraph in the article. Use graph(s) to supportyour answer.
b. Identify the concept of a change in demand, from the paragraph in the article that relates to a change in preference. Use graph(s) to support your answer.
c. Identify the concept of a normal or inferior good, from the paragraph in the article.

The latest decline in apartment prices in the capital cities of Melbourne and Sydney are due to several factors.One main factor driving apartment prices down in Melbourne is the increase in new apartments into the market is much greater than the increase in the demand for new apartments. Explain, with demand and supply diagrams, the impact on price and quantity for new apartments.

Ceteris paribus, at the same time when the demand for yoga service has increased the government has also introduced strict regulations that has resulted in a fall in the number of yoga service providers. Using demand and supply graphs illustrate and explain the impact on the equilibrium price and quantity in the market for yoga service? (HINT: There is more than one possible outcome).

a. If you owned a business, how will you apply your understanding of price elasticity of demand in your pricing policy? Use a numerical example in your answer.
b. The Western Australian government is thinking of setting a minimum price on alcohol in order to minimise the risk of alcohol related illness. Graphically represent and explain the possible impact of the government decision on the market for alcohol.

Assume, in an industry where there are no barriers to entry and firms are making an economic loss in the short run.
a. What options are available to firms in the short run to minimise their losses
b. Using demand and supply analysis together with the cost curves, explain why firms’ will only make normal profit in the long run.

Opportunity Cost and Decision Making
1. Opportunity cost refers to the benefit that is foregone due to not selecting the next best alternative. (Samuelson & NordHaus, 2010) .

For example, in the last week, I had the choice between spending my Saturday evening either working as a wait-staff at a local restaurant or watching a movie. I chose the movie. Hence, my opportunity cost is the total monetary value of my earnings as a wait staff that I could have earned. This is depicted in the diagram below. If the wages were considerably high and were greater than the utility derived from watching the movie, such as point A, then my decision would have been to pick up the job.

This is because the opportunity cost of watching the movie would be a better alternative and not the next best alternative. However, the earnings were low and the utility from watching the movie was high, such as at point B. The opportunity cost (earnings) was the next best alternative. Hence, my decision was to watch the movie.

1. b) A decrease in the price of Solar Panel below the equilibrium will cause the demand for solar panels to increase. This will result to a shift of the demand curve towards the right as price decreases from P1 to P0 (Mankiw, 201Illustration 1: The Effect of a 50% increase in the price of electricity. Source: Prepared by Author Adapted from (Chauhan, 2009)

An increase in the price of electricity will lead to a proportionate decrease in the demand for electricity, depending on the price elasticity of electricity. As a result, the demand curve will shift towards the left since fewer units of electricity would be demanded. (Mankiw, 2014)

Question 2

1. The Law of demand suggests that as the price of a good drops, the demand for the good increases. In Paragraph 1, Grannie Mae decided to purchase two extra kilos of apples, instead of her regular demand . This is evidence of the law of demand. (Samuelson & NordHaus, 2010)

In the diagram above, the demand for Granny Smith apples increases and is depicted by a shift in the demand curve towards the right.

1. b) In Paragraph 2, Granny smith wishes to buy a new product or iteration of a walking frame, instead of her regular walking stick. This change of preference was influenced by her friends and left to a shift in demand for both, the older walking sticks as well as the newer variety (frames) available. In market terms, the total demand for the older walking stick decreased by 1 while the total demand for walking frames increased by 1. (Samuelson & NordHaus, 2010)

The demand for walking sticks against a competing product the walking frame can be depicted using an Indifference curve. The utility derived from the stick and frame is the same for the consumers. Hence, they are indifferent to the two. Thus, as the demand for walking sticks decreases, the demand for walking frame moves right on the curve.

Grannie Mae prefers the leisure of staying at home. In case of a normal good, if the consumer has greater income, they would demand more quantity of a good. It is natural that Grannie Mae should choose more leisure at home. However, as her income rises due an increase in income, Grannie Mae prefers less of time spent at home and leisure associated with it. Instead she chooses to travel. Hence, leisure time spent at home is an inferior good in this case as less quanity id demand as the income of the consumer increases. (Samuelson & NordHaus, 2004)

Like any other normal good , housing too follows a demand and supply mechanism. Thus, an increase in the supply of housing in Melbourne, will reduce the price of housing, leading to an increased demand for housing in Melbourne in turn.

Elasticity of Demand and Pricing Strategies

The  total number of consumers demanding Yoga services has decreased while the number of Yoga service providers has increased. This implies that Yoga service providers who have not exited the market can command a higher price for their services. However, the super-normal profits may be short-lived since new suppliers will try to gain entry to market, despite stricter regulations and the price for Yoga services have increased. Some consumers who may not be able to pay for the increased prices will exit the market. (Chauhan, 2009)

Question 5

1. a) ‘Price elasticity of demand’ is defined as the the “degree of responsiveness of a change in demand to a change in one of its determinants while other determinants remain unchanged.” (Chauhan, 2009). It is measured as

“Price Elasticity of Demand = ((Change in Quantity Demanded)/(Total Quantity Demanded))/

((Change in Price)/(Total Price))

Let us assume that I own a food processing plant producing various food products. Those items that have lower elasticity of demand shall not show a decrease in demand with every price  change. Hence, the prices of these provisions would tend to have periodic price rises. On the other hand, those clothes that tend to have greater elasticity would tend to show a proportionately greater decrease in prices with every increase in price. Hence, these products would tend to have fewer increases in price. Thus, sales volumes would be key to retaining these products.

For example, the price of refined sugar per packet is \$2 while the price of per small packet of   ready-to-eat soup is \$2. However, sugar tends to have lower elasticity of demand. The total demand from one store per month is 100 packets of sugar and 100 packets of soup. Since there are no studies provided yet, let us assume that for every \$0.10 increase, 10 packets of sugar are demanded less while for every \$0.10 increase in price, the reduction in demand is 25 packets of soup. Hence, the total impact of

a \$0.10 increase in sugar packet price will lead to a total loss of \$20.

However, the revenue gained will be \$90. Hence, it would be profitable to increase the price of sugar.

For soup packets, an increase in price will lead to a loss of \$50 while the total revenues gained will \$7.5. Hence, it is not profitable to increase the price of the soup packets.

1. b) The proposal of Australian Government is almost similar to a floor price. A minimum price will tend to increase the total price of alcohol. Thus, the demand for alcohol will decrease proportionate to the consumers' price elasticity of demand of the consumer.

In the diagram below, as price rises from P0 to P1, supply remaining the same, the demand will decrease and the demand curve will shift towards the left.  (Chauhan, 2009) However, the impact will not just be limited to consumer demand. It is possible that some consumers may not be able to absorb the prices and may have to exit the market, in order to stay competitive. In such as case , the supply will decrease and this may push the prices, slightly higher. The overall effect depicted in the diagram above will be repeated.

Question 6

The market described in this context is a pure competition market.In the Short-run, if the firm is making losses, then the firm must reduce its average cost and marginal cost or be priced out of the market. Costs of a firm generally, tend to be either fixed or variable costs. Fixed costs are those costs that cannot be changed. For example, rent for the plant. Variable costs are those costs that can be changed. For example, labour costs etc. In the short run , the average variable costs or the costs that can be changed must be reduced as it would not be possible for firms to reduce the variable costs. In order to minimize losses, Average Variable Costs and Marginal Costs must be minimized.  (Chauhan, 2009)In the diagram below, the average costs and marginal costs are given:

In the long run, since there are no barriers to entry or exit, more and more firms can enter the market. The increased competition will force firms in a pure competition to sell products at the Average Cost or be priced out of the market. Thus, in the long run, the Average Cost is equal to the price. These are normal profits. If the average cost is greater than the price, then the firm will earn super.-normal profits. However, this is not possible in a perfectly competitive market. Hence, the cost curve will look as above.

References

Chauhan, S. P., & Chauhan, S. P. (2009). Microeconomics: An Advanced Treatise. PHI Learning Private Limited.

Principles of Microeconomics. (2014). Cengage Learning.

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