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Supply and Demand and Next-best Alternative

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    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 alse 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. 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.

    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 additional alternatives. Only when one of the additional alternatives’ values is larger than the value of the original next-best alternative, this controversial statement is valid, otherwise, not. Q(2. 1) Consider the following stock price and volume information extracted from the newspaper. a) Based on how the closing price and volume of each stock changed between 3 August 2011 and 4 August 2011, state whether each stock has experienced a decrease in demand, an increase in demand, a decrease in supply or an increase in supply, assuming there were changes in either the demand or supply curves but not both.

    The closing price of each stock can be considered as the market equilibrium price and the volume transacted of each stock represents the market equilibrium quantity. Thus, it is not necessary to focus on the highest price or the lowest price of each stock.  For the stock of HSBC, Table 3 and Table 4 show that its closing price dropped from $77. 00 to $76. 15 and its volume transacted also declined from 29,743 (1,000s) to 19,381 (1,000s). This is because the demand curve of this stock shifts to the left.

    Consequently, HSBC’s stock should have experienced a decrease in demand. As for the stock of MTRC, the closing price rose from $26. 00 to $26. 10 and its volume transacted declined from 4,398 (1,000s) to 2,424 (1,000s). As shown in Figure 2, the supply curve of its stock shifts to the left. It reveals a decrease in supply of MTRC’s stock. In terms of the stock of Cathay Pacific, the closing price fell from $17. 82 to $17. 60 and the volume transacted raised from 9,030 (1,000s) to 11,533 (1,000s). According to Figure 3, the supply curve of its stock shifts to the right.

    It suggests that Cathay Pacific’s stock should have experienced an increase in supply. b) Suppose on 4 August 2011 HSBC closed at $77. 00 instead of $76. 15 (and all other information remains unchanged), explain how you would conclude about the shifts of its demand and supply curves between 3 and 4 August 2011. The equilibrium price did not change, but the equilibrium quantity descended from 29,743 (1,000s) to 19,381 (1,000s). It is apparent that both the demand and the supply of this stock had decreased the same magnitude.

    Although the decrease in demand will result in a lower equilibrium price and a smaller equilibrium quantity, the tendency of depressed price is offset by the tendency of increasing equilibrium price due to the decrease in supply. In this case, supply curve and demand curve must shift to the left in the same magnitude. c) Suppose on 4 August 2011 the volume of MTRC was 4,398 instead of 2,424 (and all other information remains unchanged), explain how you would conclude about the shifts of its demand and supply curves between 3 and 4 August 2011. The equilibrium quantity remained the same, but the equilibrium price went up.

    It appears that the increase of demand and the decrease of supply of this stock were of the same magnitude. Although the increase in demand will result in a higher equilibrium price and larger equilibrium quantity, it is offset by the tendency of a decrease in equilibrium quantity due to the decrease in supply. So, the supply curve shifts to the left while the demand curve shifts to the right. The magnitude of left shift of the supply curve is almost the same as the magnitude of right shift of the demand curve so that the equilibrium quantity could remain unchanged.

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    Supply and Demand and Next-best Alternative. (2016, Dec 17). Retrieved from https://graduateway.com/supply-and-demand-and-next-best-alternative/

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