Economic Principle and Microeconomics Concepts

This article covers various microeconomics concepts such as opportunity cost, demand and supply, price elasticity, market structure, and more. It also includes relevant diagrams and examples.

ECONOMIC PRINCIPLE
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Question 1
(a) Opportunity cost refers to the foregone benefit of the next best alternative when a given
alternative is chosen (Arnold, 2015).
An example of opportunity cost was faced when recently my friend asked for some money. I
withdrew the money from my account where I was deriving an interest rate of 3% p.a. Thus,
by giving my friend the money, I had an opportunity cost in the form of foregone interest on
the amount. As a result, I asked my friend to pay the same as interest on the loan so that I am
not at a loss and I could also help a friend in need.
b) In the given case, the effect of the following events needs to be highlighted with the use of
demand and supply diagrams.
(i) Owing to the decrease in the prices of solar panels below the equilibrium price, the
following situation would arise.
As is evident from the above diagram, at a lower than equilibrium price, the quantity
demanded (Qd) is significantly higher than quantity supplied (Qs). As a result, there is a
shortage in the solar panel market which in the long run would raise prices (Mankiw, 2014).
(ii) It is known that the price of electricity has increased by 50% owing to which the
consumers would look for cheaper alternatives. One of these would be solar panel. As a
result, there would be an increase in the demand of solar panels which would now be more
competitive against other means of producing electricity.

Owing to higher demand, a shift in the demand curve would be observed from D1 to D2 as
indicated in the above graph. On the other hand, the supply curve remains constant in the
short run and hence the equilibrium point changes. The new equilibrium price and quantity
would both be greater than earlier (Krugman and Wells, 2014).
Question 2
a) In accordance with law of demand, assuming everything else remains the same, the
demand and price of a product are inversely related. As a result, when prices decrease the
demand would increase. The law of demand can be captured using the following diagram
(Arnold, 2015).
This is exhibited with regards to Granny Smith Apples whose price has reduced and hence
the demand from Grannie Mae has increased from 1 kg to 3 kg per week.

b) The concept of change of demand implies changes in demand owing to non-price factors
such as change in preferences. This would lead to a shift in the demand curve based on
whether the new demand is greater or lesser than the previous demand (Mankiw, Mankiw and
Taylor, 2011).
The concept of demand in the given article is illustrated on account of preference change
from a walking stick to a walking frame. As a result, the demand of walking stick would
decrease leading to shift from D to D2. On the other hand, the demand of walking frame
would increase leading to shift from D to D1 (Nicholson and Snyder, 2014).
c) Normal good is one whose demand would increase when the income levels of the
consumer would increase. Inferior good refers to a good whose demand decreases when the
income levels increase (Mankiw, 2014). An example of inferior good is walking stick since
despite the increase in pension; Grannie Mae does not purchase it. An example of normal
good is walking frame whose demand has increased as pension has increased.
Question 3
The prices of apartments are dependent on the underlying demand and supply of apartments.
In the given case, it is highlighted that in the recent times, there has been increase in the new
apartment which would lead to higher supply of apartment. The impact of this is highlighted
in the graph indicated below.

The increase in supply of apartments had led to shift in the supply curve from S1 to S2. The
demand curve in the short run does not alter and remains the same as exhibited above. The
net result is that the equilibrium point of the apartment market changes with price decreasing
from P1 to P2 and quantity purchased increased from Q1 to Q2. This is why the apartment
prices in Sydney and Melbourne recently have witnessed a decline (Krugman and Wells,
2014).
Question 4
In the given case, there are two factors that are at play simultaneously. On one hand, the
demand of yoga is increasing owing to the altering preferences of the consumers which
would lead to a shift in the demand curve such that a higher demand is exhibited at existing
prices. On the other hand, government has put a restriction in regards to yoga service
providers which has resulted in falling service providers. This would lead to reduction of
supply and since the supply reduction is on account of non-price factors, hence the supply
curve would shift to provide lower supply at existing prices. The combined change of the two
simultaneous changes is reflected in the following demand supply diagrams based on
quantum of demand increase and supply decrease.
Scenario 1: Increase in demand = Decrease in supply
The relevant diagram is shown below.

In the above diagram, there is an increase in demand resulting in shifting of demand curve
from D to D1. Simultaneously, there is a reduction in supply which would lead to shift of
supply curve from S to S1. The net effect of these changes as highlighted from the above
graph is that equilibrium price has increased from P to P1 while the equilibrium quantity has
not changed. Hence, there is an increase in equilibrium price without any change in the
equilibrium quantity (Arnold, 2015).
Scenario 2: Increase in demand > Decrease in supply
The relevant diagram is shown below.
In the above diagram, there is an increase in demand resulting in shifting of demand curve
from D to D1. Simultaneously, there is a reduction in supply which would lead to shift of
supply curve from S to S1. The net effect of these changes as highlighted from the above
graph is that equilibrium price has increased from P to P1 while the equilibrium quantity has

increased from Q to Q1. Hence, there is an increase in equilibrium price with a corresponding
increase in the equilibrium quantity (Nicholson and Snyder, 2014).
Scenario 2: Increase in demand < Decrease in supply
The relevant diagram is shown below.
In the above diagram, there is an increase in demand resulting in shifting of demand curve
from D to D1. Simultaneously, there is a reduction in supply which would lead to shift of
supply curve from S to S1. The net effect of these changes as highlighted from the above
graph is that equilibrium price has increased from P to P1 while the equilibrium quantity has
decreased from Q to Q1. Hence, there is an increase in equilibrium price with a
corresponding decrease in the equilibrium quantity (Mankiw, Mankiw and Taylor, 2011).
Question 5
a) The concept of price elasticity can be applied in business for the decision of taking the
price hike or not. Generally, when the demand for underlying product or service is elastic, the
prices should be reduced. However, when the demand for underlying product or service is
inelastic, then revenue hike would lead to maximisation of profits (Nicholson and Snyder,
2014).
Consider a product which has a price elasticity of demand of -0.1. Let the current sales be
100 units at a price of $ 10. The business owner now needs to make a decision whether the
price should be increased or not by $ 1.
Increase of $ 1 in percentage terms would be (1/10) or 10%

Price elasticity of demand = Percentage change in quantity demanded/Percentage change in
price
Percentage change in quantity demanded = -0.1*10 = -1%
As a result, the sales volume would be 99 units
Previous revenue = 10*100 = $ 1,000
New revenue = 11*99 = $ 1,089
Based on the above, it is in the interest of the business owner to raise prices.
b) The impact of levying minimum price on alcohol can be highlighted using the following
diagram.
It is apparent that owing to the minimum price above the equilibrium price, there would be
excess supply in the market since at higher prices the demand would be comparatively lesser
and hence supply would be higher. The excess supply in the market would be dumped at
lower prices till there is an equilibrium established between demand and supply. Therefore, in
the short run, the supply of alcohol in the black market would increase and without
regulation, it is possible that the quality may be severely compromised which can lead to
higher illness on account of alcohol (Krugman and Wells, 2014).
Question 6
a) The concerned market structure is perfect competition. In this case, the sellers are
essentially price takers and thereby the only decision that remains with them is the quantity
that should be produced for profit maximisation. IF at optimum production level i.e. where
MR=MC, the business is not able to even recover the fixed costs, then the production should

be made zero so that the losses equals to the fixed costs. However, if the fixed costs are
recovered, then the production should be continued as the loss incurred during production
would be lower than with zero production (Pindyck and Rubinfeld, 2015).
b). In perfect competition, the firms in the long run tend to make normal profits irrespective
of the abnormal profits they might be making in the short run. This is because, there are no
entry barriers and hence in the long run new firms tend to enter or exit the market so as to
ensure that the supply in the industry is adjusted so that there is profit normalisation. This is
indicated in the following diagram (Mankiw, 2014).
It is apparent that ATC is at the lowest point indicating maximum cost efficiency.

References
Arnold, A.R. (2015) Microeconomics. 9th ed. Sydney: Cengage Learning.
Krugman, P. & Wells, R. (2014) Microeconomics 2nd ed. London: Worth Publishers.
Mankiw, G. (2014) Microeconomics. 6th ed. London: Worth Publishers.
Mankiw, G.N., Mankiw, G.N. and Taylor, P. (2011) Microeconomics. 5th ed. Sydney:
Cengage Learning.
Nicholson, W. and Snyder, C. (2014) Fundamentals of Microeconomics.11th ed. New York:
Cengage Learning.
Pindyck, R. and Rubinfeld, D. (2015) Microeconomics 5th ed. London: Prentice-Hall
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