Opportunity Cost, Absolute And Comparative Advantage, Elasticity Of Demand And Revenue Calculation

1. You and your friend Joe have identical tastes. At 2 pm, you go to your local Ticketmaster outlet and buy a $30 ticket to an AFL game to be played that night in Launceston, 200 kilometres north of your home in Hobart. Joe plans to attend the same game but, because he cannot get to a Ticketmaster outlet, he plans to buy his ticket at the game. Tickets sold at the game cost only $25, because they carry no Ticketmaster surcharge. (Many people nonetheless pay the higher price through Ticketmaster, to be sure of getting good seats.) At 4 pm an unexpected hailstorm begins, making the prospect of driving to Launceston much less attractive than it was before (but assuring the availability of good seats). If both you and Joe are rational, is one of you more likely to attend the game than the other?

2.Nancy and Lucy are studying economics. Nancy takes 4 hours to write an assignment and two hours to complete a set of tutorial questions. Lucy takes 6 hours to write an assignment and 2 hours to complete a set of tutorial questions. State whether either woman has an absolute advantage at either task and, for each task, identify who has a comparative advantage. Why would Nancy and Lucy never agree to specialise and then exchange economics assignments for economics tutorial questions if one economics assignment could be swapped for three economics tutorials?

3. The table below shows the number of croissants bought in Geelong, Victoria, each day at a variety of prices.

a. Graph the daily demand curve for croissants in Geelong.

b. Calculate the price elasticity of demand at the point on the demand curve at which the price of croissants is $3.

c. If all bakeries increased the price of croissants from $3 to $4, what would happen to total revenues?

d. Calculate the price elasticity of demand at a point on the demand curve at which the price of a croissant is $2.

e. If all bakeries increased the price from $2 to $3 per croissant, what would happen to total revenues?

4. In which type of restaurant would you expect the service to be more prompt and courteous: an expensive gourmet restaurant or an inexpensive cafe? Explain.

Question 1: Opportunity cost and Sunk costs

1 Opportunity cost and Sunk costs

Identical tastes in our case here means that Joe and I could enjoy similar services and get equal utilities (Ferraro & Taylor, 2005). The product we are to enjoy here is watching the AFG game at the same night. Since I was able to go to the Ticketmaster, I purchased by ticket in advance at a price of $ 30. But since Joe wasn’t able to go to the Ticketmaster, his plans is to buy ticket at the game at $ 25. Assuming we were rational, if the prospect of driving becomes much more unattractive, I will be left as the only person most likely to go watch the game irrespective of the bad weather. There is a high probability that Joe’s idea of going to watch the game will be disregarded. Why? I personally have paid for the ticket and am assured of getting a good seat at the game. Failure to attend the game won’t result in a refund for the ticket money I had already purchased (Mankiw and Taylor, 2006). Since the money is nonrefundable, I’ll be looking forward to get a sunk cost of $ 30 (Arnold, 2010). Hence, there is a high chance that I will attend the match. Joe has not yet paid for the tickets and thus is not assured of getting a good seat. The fact is that if he doesn’t attend the game, he won’t lose anything; but if he attends he has to pay $ 25 for the ticket at the game. Thus the $ 25 is the opportunity cost of going to the game. Opportunity cost according to Lal & Srivastava (2009) is the cost of foregoing alternatives. The poor weather prospective, the low possibility of getting a good seat, and the $ 25 opportunity cost minimizes the chances of Joe attending the game.

2

The table above shows the time taken by the two women to complete two different tasks. The time taken in completing task one (an economic assignment) by Nancy is 4 hours whereas that taken by the other woman (Lucy) is 6 hours. Comparing the time taken in doing the first task which is an equal task shows that Nancy is doing it more efficiently than Lucy since she is taking lesser time (Hall & Lieberman, 2008). For this reason, it’s Nancy who has an absolute advantage in writing economic assignments. On the other hand, it can be observed that the two women takes equal time in doing the second task (the completion of tutorial questions). Therefore it can be concluded that neither Nancy nor Lucy has an absolute advantage in the completion of tutorial question sets. Having compared the two women in absolute terms and concluding that it’s only present for task one, and it’s by Nancy, we now compare them in comparative advantage terms.

Comparative advantage is present in any of the parties being compared irrespective of whether a single party has an absolute advantage over the other. Hence, either Nancy of Lucy will have a comparative advantage. The decision making is done by comparing the opportunity cost of both women in completion of the second task. The woman with the lowest opportunity cost will be concluded to have a comparative advantage over the other. If Nancy completes a set of tutorial questions, her opportunity cost is writing half of an economic assignment (2/4 =1/2). On the other hand, if Lucy completes a set of tutorial questions, her opportunity cost is writing a third of an economic assignment (2/6 = 1/3). Comparing the magnitude of the two opportunity costs, it can be deducted that;  . The conclusion thereby is that, Lucy has a comparative advantage in the completion of tutorial question sets. Similarly, is Nancy writes an assignment, her opportunity cost is 2 sets of complete tutorial questions. On the other hand, if Lucy writes an assignment, her opportunity cost is 3 sets of complete tutorial questions. In comparison, Nancy’s opportunity cost is lower (2 3). The conclusion thereby is that, Nancy has a comparative advantage in the Writing of economic assignments. The summary thus is such that whereas Nancy has an absolute advantage in writing assignments, Leah has a comparative advantage in completing tutorial questions. However, Nancy also has a comparative advantage in writing of the economic assignments.

Question 2: Absolute and comparative advantage

Specialization is possible when parties have comparative advantage over the others (Wolak, 2011). Since both tasks has to be completed by each woman, each could do the task which she is more efficient with and swap for the other. Specialization in this case is such that an economic assignment is swapped for 3 finished tutorial questions. If Nancy writes her own assignment, the swapping couldn’t be possible because what she now need is a single finished set of tutorial questions. On the other hand, if Lucy finishes 3 sets of tutorial questions to swap for an economic assignment, it would still be equivalent to writing an own assignment since she would take 6 hours. These arguments clearly confirm why specialization and hence swapping is not applicable.

3a

Fig: Croissant prices against its demand at a variety of prices

3b

This is obtained by calculating the price elasticity of demand at a given point. It is found by using the formula below

Price elasticity of demand =  

Q = 6000 – 9000 = - 3000        Q = 9000

P = 4 – 3 = 1      P = 3

P elasticity of demand =  =  = -1

3c

Initially the price for croissants is $ 3, and the corresponding quantity demanded is 9000.

The total revenue (QP) = 9000 * 3

 = $ 27,000

After the price for croissants was raised from $3 to $ 4, the corresponding quantity demanded fell to 6000 units.

The total revenue (QP) = 6000 * 4

= $ 24,000.

Therefore, it can be concluded that at the price of $ 3, the firm makes a higher revenue than when the price is raised to $ 4. This is because the reduction in quantity demanded after a unit price increment is very high.

3d

Recall,

Price elasticity of demand =

Q = 9000 – 12000 = - 3000        Q = 12000

P = 3 – 2 = 1      P = 2

P elasticity of demand =  =  

= -0.5

3e

Initially the price for croissants is $ 2, and the corresponding quantity demanded is 12000.

The total revenue (QP) = 12000 * 2

 = $ 24,000

After the price for croissants was raised from $2 to $ 3, the corresponding quantity demanded fell to 9000.

The total revenue (QP) = 9000 * 3

= $ 27,000.

Therefore, it can be concluded that at the price of $ 3, the firm makes a higher revenue than when the price is raised to $ 2. This is because the reduction in quantity demanded after a unit price increment is at a lower price elasticity of demand as compared to part (b) above.

It therefore can be concluded that the price of $ 3 is the profit maximizing price with the corresponding quantity of 9000 units.

4 The services offered in an expensive gourmet restaurant are more prompt and courteous than in inexpensive restaurants. Richard (n.d) confirmed this statement by noting that the higher income of those who go to the expensive restaurants determine the quality of the services offered. The services are prompt since in expensive restaurants they employ more clerks and use expensive equipment in order to facilitate the service offering (McKeever, 2013). Furthermore, most people are willing to go for cheaper things and thing explain why there are a lot of people in inexpensive restaurants which affect the speed of services and their quality. The rich willingness to pay more for prompt services is high.

References:

Arnold, A. (2010). Microeconomics. Mason, OH, South-Western Cengage Learning.

Ferraro, P., & Taylor, L. (2005). Do Economists Recognize an Opportunity Cost When They See One? A Dismal Performance from the Dismal Science. Contributions in Economic Analysis & Policy, 4(1). https://dx.doi.org/10.2202/1538-0645.1469 

Hall, E. & Lieberman, M. (2008). Microeconomics: principles and applications. Mason, OH, Thomson/South-Western.

Lal, J. and Srivastava, S. (2009). Cost accounting. New Delhi, Tata McGraw-Hill.

Mankiw, G. & Taylor, P. (2006). Economics. London, Thomson.

McKeever, A. (2013). How Restaurants Are Stepping Up Their Coffee Game. Eater. Retrieved 3 April 2017, from https://www.eater.com/2013/10/16/6351307/how-restaurants-are-stepping-up-their-coffee-game.

Richard, (n.d.). Demand: The Benefit Side of the Market. [Online] Retrieved 3 April 2017, from https://file:///C:/Users/Richard/AppData/Local/Temp/Chapter5.pdf [Accessed 2 Apr. 2017].

Wolak, F. (2011). Our Comparative Advantage - NYTimes.com. Nytimes.com. Retrieved 3 April 2017, from https://www.nytimes.com/roomfordebate/2011/01/18/can-the-us-compete-with-china-on-green-tech/our-comparative-advantage