Economics – Choice – 1000 words

Economics:

Question No 1

1. A) Choice as an economic concept is a direct consequence of scarcity of the resources available at a given time and the fact that there cannot be an infinite supply of anything. Opportunity cost then becomes a corollary of this concept and denotes that while choices will have to be made they will have to be “rational” from an economic point of view. This also brings in the slightly relevant issue then of taking into account needs and wants when making a rational choice. Opportunity cost then means the cost of making a decision to have X in terms of the availability and possibility of obtaining Y.For example if X=1 dollars and Y=1 dollar and a person having 5 dollars would be faced with the opportunity cost of having 5 units of X as 5 units of Y and vice versa.

1. B) The law of demand shows that the quantity which will be demanded of X or Y product at any one point will manifest itself as a strong function of its price. When the demand curve is plotted it will show that the quantity (independent variable) and demand (the dependant variable) will bring about a downward slope, which denotes the factum that basically the quantity being demanded will move in a separate direction of the price given that all other extraneous factors remain constant.

The fact that a demand curve would shift to the left means that less of its quantity is in demand right now and this can mean that the price of the product would now fall. This can happen for a number of reasons. For example if we take the example of Nike sports shirts the consumer preference for the same can decrease in the winter season as people would be looking for warmer clothing and thus due to the decreased quantity being demanded the price of the product would fall as well. Another reason could be the presence of cheaper alternatives or brand competition from other companies. For example Tesco is known for its excellent sportswear, which might lack the Nike brand, but it has the same material and design to it at a lower price. Lower price might attract the consumer base of the Nike buyers to Tesco and this can cause the demand curve for Nike to shift to the left where it will be faced with a decision to charge less money for its shirts if it would like to sell more of its products.

In terms of a supply curve, the time when it will shift to the right will be when more of the quantity of a product is being supplied at a lower price. This generally happens when there is a bumper crop in developing countries for a certain agricultural product like apples or wheat .One reason for this because there is a large quantity of apples or wheat being offered by many suppliers or farmers there will be more “sales” and “discounts” available than in seasons when such products are scarce. Another reason can be the cheaper price of similar food items for example oranges or rice.

Answer to question number 2-

All diagrams below are  the courtesy of http://www.forecasts.org/oil.htm

1-It is important to understand the nature of the oil market before embarking upon an analysis of how its demand or price is determined. Essentially it is important to realise that geo-political changes and the increasing number of man-made and natural disasters can affect the short-term price of oil like it did in 2008 when there were one too many political crises happening. The looming sub prime crisis was also one reason here. Important events, which followed up to the price hike, were the middle-east crisis, nuclear threats from Iran and a collapsing world over banking system. By 2008 the world was seeing the after effects of a recessive economic atmosphere fuelled by the sub prime crisis and the development of alternative forms of renewable, coal and nuclear energy allowed the price to plunge upwards. This further increased transportation and industrial costs and there was an increase in inflation. Things have since then normalised and the price of oil if not as high as 2008 did manage to become lower in 2009.

The price of oil remains an important consideration for firms because higher oil prices mean an increase in production and transportation costs would mean an in increase in the pricing of their products or services. Once there is an increase here the demand for the same products or services is likely to go down thus causing a lot of financial loss to the firms.

It is important to understand that the long term and short-term price of oil is influenced by different factors. The following is th short-term demand curve for oil which where a large change in price is likely to have little effect on oil demand

It should also be noted that in the short term Oil supply is likely to be inelastic due to the cost infrastructure and availability of crude oil.The following diagram for short term prices then shows how small changes to the supply or demand curve will cause large changes to the real price of oil.

The long term price of oil is however more elastic and in the next ten years the control of the USA on Iraqi oil reserves will probably mean that there will be much more oil available and the price of oil will fall regardless of how serious the situation is in the middle-east. Even though the oil reserves are diminishing world wide and an oil crisis is expected in 50 years or so fact that people are adopting to alternative and renewable forms of energy simply means that oil will be less costly.Also new technology and new venues of oil drilling may contribute to the oil supply in which scenario the prices of oil are also likely to fall.

Q-3 Price elasticity of demand

Elasticity of demand for a certain product is an indication to how its quantity demanded is likely to respond to any one of its determinants. A highly inelastic product is likely to have any substitutes for it.I the demand for a product is elastic that is it has many substitutes or is more of a want than the need of its consumers its price increase is likely to decrease its quantity demanded.

The following is an example of an inelastic and inelastic demand curve for a product.

1. A) Inelastic demand curve B) Elastic demand curve

The relationship between price elasticity of demand and the total revenue

1. A) When the price changes from 16 to 14 the price is relatively elastic and hence the total revenue increases but the marginal revenue decreases. This means that there was not any significant effect of the price decrease and although it increased the quantity demanded this was not as much as before.
2. B) When the price changes from 10 to 8 the price is relatively inelastic and any price change instead of bringing in more total revenue actually decreases it and the fall in the Marginal revenue is also accelerated at this point.

References

• Backus, D. and Driffill, J. (1985) Rational expectations and Policy credibility-South-Western College Publishing.
• Goose (2007) The Economics of Oil, Part I: Supply and Demand Curves -August 19, available at http://www.theoildrum.com/node/2899
• Krugman; Wells (2009). Microeconomics (2nd ed.). Worth.
• Maunder, P (2008) Economics Explained, Revised Edition
• Tucker, I. B. (2000), Market structures; Monopolistic competition and oligopoly, Economics for Today:  South-Western College Publishing.