Opportunity Cost, Demand and Supply

This study material discusses the concepts of opportunity cost, demand, supply elasticity, and profits. It explains the concept of opportunity cost with an illustration and explores the effects of changes in wages, access to quality cattle, and simultaneous shifts in demand and supply curves. It also discusses the elastic and inelastic demand for heroin and the effect of price control on super chicken. Finally, it explains how a firm can stay in the market without making profits.

Opportunity Cost, Demand and Supply 1
OPPORTUNITY COSTS, DEMAND, SUPPLY ELASTICITY, AND PROFITS
By Student’s Name
Course
Tutor
University Affiliation
City
Date

Opportunity Cost, Demand and Supply 2

Opportunity Cost, Demand and Supply 3
Opportunity Costs, Demand, Supply Elasticity, and Profits
Question 1
Opportunity cost and illustration
Opportunity cost is the highest value of an alternative that a consumer must sacrifice to
satisfy their wants or obtain something (Krugman & Wells, 2013). Faced with options spending
100 RM on purchasing exercise books and pens, a student has to give up some pens for an
exercise book or some exercise books for a pen if an exercise book costs 20 RM while a pen
goes at 10 RM. The combinations of what the student can buy are shown in the diagram below.
0 2 4 6 8 10 12
0
1
2
3
4
5
6
E
E
D
C
B
A
Pens
Exercise books
As can be seen in the graph, the student at point C can purchase 3 exercise books and
four pens. However, if the student wishes to have six pens, they have to give up 1 exercise
book to buy two extra pens at point D. Therefore, the opportunity cost of an exercise book is the
cost of buying two pens.

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Question 2
a. The decrease in wages on demand for beef
When the average income of the consumers decreases, their purchasing power
decreases as they will have less disposable income. Assuming beef was a normal good,
a decrease in average wages of consumers will result in a decline in the demand of the
beef assuming that considering beef was a normal good. A leftward shift in the demand
curve is used to demonstrate the effects.
b. Access to quality fast-maturing cattle
When farmers have improved technology in production (access to quality cattle
that mature quickly) getting cattle to the market soon, the number of cows slaughtered in
a given period increases. Thus, the quantity of beef supplied to the market is likely to
increase ceteris paribus. The effect of such a dynamic is demonstrated by a shift in the
supply curve as shown below.

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All else constant, the equilibrium quantity of beef increases as its equilibrium
price falls as shown above.
c. The simultaneous shift in demand and supply curves (in opposite directions) with
all factors kept constant.
The immediate effect of the state order to slaughter more cattle is an increase in
the supply of beef. However, the state warning of the imminent mad-cow disease
reduces the quantity of beef demanded by the consumers. Both factors lead to a shift in
supply to the right and a leftward shift in the demand curve. The resultant effects on the
equilibrium price and quantity will differ depending on the which shift of the two forces
(demand and supply) dominates the other. As observed in the panels below, price
reduces from P1 to P2 whereas changes in equilibrium quantity are ambiguous.

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In panel 2.3, the shift in demand is higher than that in supply. Thus, the
equilibrium quantity of beef falls from Q1 to Q2 as shown while the equilibrium price falls
drops from P1 to P2.
In panel 2.4 below, the shift in supply dominated that of demand. Consequently,
the equilibrium quantity increases from Q1 to Q2 as shown. Here, supply dominates the
demand.
Lastly, in panel 2.5, none of the two forces dominates the other. Thus, the impact
of the changes in demand and supply balances each other. In that case, the equilibrium
remains the same regardless of the drop in the equilibrium price.

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All else being equal, there are three possible scenarios when the government
orders the slaughter of cattle at the same time warning consumers of a likely outbreak of
mad cow disease. The equilibrium price of beef falls in relatively equal terms whereas
the equilibrium quantity may decrease, increase or remain unchanged depending on
whether the shift in supply; dominates shift in demand, is less than the shift in demand or
is equal to that in demand respectively.

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Question 3
Elastic demand for heroin vs. inelastic demand of heroin: The case of arrest of heroin
traffickers
The arrest of drug major heroin barons leads to a considerable decrease in the supply of
heroin because it will scare the remaining drug traffickers into hiding. There will be a shortage of
heroin. Even so, the sale occurs in the black market necessitating an increase in price even to
abnormal levels.
Given that the demand for heroin is assumed to be elastic, it is likely that the revenue
accrued to the drug barons will reduce. Consumers, being highly responsive to price changes,
will reduce their demand for the drug. According to Krugman and Wells (2013), the quantity
effect in elastic a demand for a good outweighs the price effect thus reducing the overall
revenue.
If the demand for heroin were inelastic, the unresponsive nature of the consumers
would lead to an increase in revenue. In this case, the effect of an increased price will be
increased revenue. It tends to overpower the reducing supply (quantity effect) on the sale of
heroin. Therefore, the overall revenue obtained by the barons will increase.
Summarily, if authorities were competent in arresting drug barons the decrease in
quantity purchased outweighs the increment in prices of heroin if its demand was elastic
whereas the price effect outweighs the reduction in amount bought if the demand for heroin
were inelastic. Overly, the revenue collected by heroin sellers is higher if its demand is inelastic
than if the demand is elastic.

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Question 4
Effect of price control on super chicken
Naturally, suppliers would increase the prices of various commodities, super chicken include.
Without control, the market would clear at a higher price say Pe as shown in Panel 4.1 below. At
the price of 7.5 RM, the producers will be willing to supply Q1 of super chicken. Conversely, the
consumers will be demanding Q3 of super chicken at the same price. Therefore, under the
influence of the price control, there will be a shortage that can be represented by Q3- Q1 shown
in the diagram below.
Shortages caused by price control will leave many of the consumers without their
desired quantity for consumption. It is likely that consumers coming late to the stores may miss
out on the chicken altogether. The circumstances surrounding the supply of these chicken
would then lead to the use of non-price rationing as suggested by Miller (2012). The devices to
be used to rationalize for the shortage include queuing and use of waiting lists.
Another possible outcome of the price ceiling introduced by the Malaysian government
would be the growth of the black market. Consumers will be frustrated to get a supply of Q1
when they should be getting more to match their demand, Q3. The black market will blossom
because the government has put in place fines for anyone who sells goods beyond the legally
imposed price. Implicitly, price control is likely to be effective, and that will facilitate the growth of
the black market. If that arises, the sellers of chicken are expected to receive gifts such as free
tickets for upcoming football matches or an extra payment for the otherwise scarce super
chicken.

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Question 5
The firm still in the market without making profits
A firm can stay in the market even after failing to earn profits. That is possible if the
following conditions permit. Entry into and exit from markets of firms eventually lead to a
reduction as shown in panel 5.1 and panel 5.2 below or an increase of prices (as shown in
Panel 5.3 and Panel 5.4) to a level E where it equals to the long run average costs. Such
occurrence is typical in the perfect competition markets where there are no impediments to
entry and exit of firms. According to Acemoglu, Laibson & List (206), When the price equals to
the average costs and coincides with marginal cost (at point E), the firm does not make either
profits or losses as shown on panel 5.1 below. The firm can stay in the market making zero
economic profits for the time being.

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References
Acemoglu D, Laibson D, & List J A 2016, Microeconomics, Global edn, Pearson, Boston.
Krugman, P and Wells, R 2013, Economics, 3rd edn, Worth Publishers, New York.
Miller R. L 2012, Economics today the micro view, 16th edn, Boston, Addison-Wesley, Boston.