Opportunity Cost, Demand and Supply

This study material covers the topics of opportunity cost, demand, supply elasticity, and profits. It explains the concept of opportunity cost and provides an illustration. It also discusses the effects of decrease in wages on demand for beef and access to quality fast-maturing cattle on supply. The study material explores the simultaneous shift in demand and supply curves and its impact on equilibrium price and quantity. It further examines the elastic and inelastic demand for heroin and its effect on revenue. Lastly, it discusses the effect of price control on super chicken and the possibility of a firm staying in the market without making profits.

Opportunity Cost, Demand and Supply 1
OPPORTUNITY COSTS, DEMAND, SUPPLY ELASTICITY, AND PROFITS
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Opportunity Cost, Demand and Supply 2
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.
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 as shown
below.
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

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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.