Supply and Demand and Next-best Alternative

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  • Topic: Supply and demand, Economic equilibrium, Partial equilibrium
  • Pages : 6 (1401 words )
  • Download(s) : 243
  • Published : November 7, 2012
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AF2601

Individual Written Report

Problem Set 1

Name: WANG Yu Dobby
Student ID: 10808309D
Tutorial Day and Time: Tuesday 12:30- 13:20
TUT 007

To be completed by marker:
Q1: _____
Q2: _____
English Proficiency: _____
Report Grade: _____

In daily life, a decision maker often has to forgo something in the pursuit of a certain action due to scarcity of resources. The value that must be forgone in order to undertake the action is defined as “opportunity cost” by the economists. Besides, another common issue for an economic learner is the variable responses of market prices and quantity due to the change in demand or supply. In this report, we will to further discuss the above issues via analyzing these two problems below: Q(1.1) "According to the definition of opportunity cost, the more alternatives that we have given up in undertaking an action, the higher the opportunity cost." Please make a critical comment on this statement and explain your answers using examples. The validity of this statement is uncertain. Opportunity cost is defined as the value of the next-best alternative that must be forgone in order to undertake the action. It is notable that the definition refers to the value of the next-best alternative forgone, not the total value of all possible alternatives. Consequently, there are two distinct situations for this statement. If none of the additional alternatives are better off than the original next-best alternative, the next-best alternative will not change so that the opportunity cost does not change. In this case, the statement is false because opportunity cost will not increase with the number of alternatives available to the decision maker. However, if at least one of the additional alternatives is better off than the original next-best alternative, the next-best alternative will definitely change so that the opportunity cost will increase which verifies the validity of the statement. Here is an example for illustration:

Suppose a farmer has a small piece of land to grow fruits for sale. There are many kinds of fruits to choose, but he can only grow one kind of them. He has no preference to any kind of fruits. To explain more clearly, it is assumed that there are only three alternatives (apples, oranges and pears) to choose from and only one additional alternative in either situation. The annual output, market price and total value of each kind of fruits are shown in Table 1 below: Table 1.

Fruit | Annual output(kg) | Price (HK$/kg) | Total value (HK$) | Apples | 10 | 10 | 100 |
Oranges| 5 | 10 | 50 |
Pears | 15 | 2 | 30 |

Watermelons | 8 | 5 | 40 |
Obviously, growing apples is the best choice as it gives him the highest revenue (HK$100 per annum). Then, the next-best alternative is to grow oranges because the value of growing oranges (HK$50 per annum) is larger than the value of growing pears (HK$30 per annum). When an additional alternative is available, growing watermelons, which the value is HK$40 per annum, the value of growing watermelons is still smaller than the value of growing oranges. Thus, the next-best alternative is still growing oranges, and there is no change in the opportunity cost. In this case, the statement is false. Table 2.

Fruit | Annual output(kg) | Price (HK$/kg) | Total value (HK$) | Apples | 10 | 10 | 100 |
Oranges| 5 | 10 | 50 |
Pears | 15 | 2 | 30 |

Peaches| 15| 5 | 75|
As shown in Table 2, in another situation, the additional alternative is growing peaches, for which the monetary return is HK$40 per annum. Due to the larger value of growing peaches (HK$75 per annum) than growing oranges (HK$50 per annum), the next-best alternative will shift from growing oranges to growing peaches. Accordingly, the opportunity cost will increase. The statement is true under such circumstances. To conclude, the validity of the statement depends on the values of the...
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