Opportunity Cost

Human wants are unlimited but the factors of production are limited. This leads to the problem of scarcity. Thus, a society must make a wise decision and choose what goods and services to produce. When the choice on what goods to produce is made, an opportunity cost is incurred. Opportunity cost of undertaking an activity is the benefit forgone by undertaking that activity. The benefit forgone is the benefit that one might have gained from choosing the next best alternative. In short, when society decided on what goods and services to produce, it’s also scarifying the production of other goods and services.

Figure 1: Production Possibility Curve and Opportunity Cost

Figure 1 presents the relationship between production possibility curve (PPC) and opportunity cost. PPC shows the maximum combination of outputs or final products that can be produced from a given number of inputs. Assume that Apple Inc. produce two type of products, iPhone and iPod. If Apple allocates all of the resources to produce iPhone (point a), then none of the iPod is produced. So, the opportunity cost to produce iPhone is to sacrifice the iPod’s production. Likewise, if Apple decided to produce iPod only (point b), the opportunity cost in this scenario is to give up the production lines that make iPhone. In point c, if Apple decided to produces both products in equal proportion, then the company must allocates part of the resources to produce iPhone and part of the resources to produce iPod. Overall, PPC slopes downward from left to right. The downward slope represents the concept of opportunity cost - you get more of one benefit only if you get less of another benefit. 

Determinants of Demand

Demand curve shows the relationship between price and quantity demanded. The determinants of demand are income, price of other goods, tastes and preferences, expectations about future prices and incomes, taxes and subsidies.

Determinants of Supply

Supply curve shows the relationship between price and quantity supplied. The determinants of supply are price of inputs, technology level, expectations, expectations, taxes and subsidies.

  

Price Elasticity of Supply and Demand

Figure 1: Elasticity of Demand

Elasticity is an important concept in economics. It is frequently used to describe the responsiveness of quantity demanded or supplied to price. Figure 1 shows the typical elasticity of demand curve. The price elasticity of demand (E_d) measures the percentage change in quantity demanded over the percentage change in price. The information derived from price elasticity of demand is very important because it tells us how quantity demanded responds to a change in price. For example, if the price elasticity of demand for iPhone 5 is 0.2, this implies that a 10% rise in iPhone 5 price will lead to a 2% fall in quantity demanded. Consumers shift their demand to other substitutable products which price are lower than iPhone like Samsung, Sony, HTC and so on. Thus, the larger the value of price elasticity, the larger the quantity responds to any price changes. As shown in Figure 1, there is various degree of price elasticity along the demand curve and the descriptions are listed below:

           

Figure 2: Elasticity of Supply

Figure 2 shows the elasticity of supply curve. The price elasticity of supply (E_s) measures the percentage change in quantity supplied over the percentage change in price. Similar to price elasticity of demand, the information derived from elasticity of supply is very informative since it measures how the quantity supplied responds to a change in price. For example, if the price elasticity of supply for iPhone 5 is 0.6, this implies that a 10% rise in iPhone 5 price will bring about 6% increase in quantity of iPhone 5 supplied. Overall, the larger the value of price elasticity of supply, the larger the quantity responds to any price changes. The descriptions on various degree of price elasticity along the supply curve are listed below:

Demand and Supply

Figure 1

Demand Curve

Demand curve is the graphical representation of the relationship between price and quantity demanded of a particular product or service.  Based on Figure 1, it is pretty clear that when price goes up, quantity demanded goes down and vice versa, other things remain constant. This shows that the price and quantity demanded are inversely related, as a result, demand curve is slopes downward to the right. This is consistent with the law of demand. The law of demand stated that:

                Quantity demanded falls when price rises, other things remain constant.

                Quantity demanded rises when price falls, other things remain constant.

The law of demand is fundamental to the invisible hand’s theory and shows its ability to coordinate individuals’ desires. For instance, as prices change, people tend to change their buying behaviors.

As mentioned above, economist have make an important assumption which is other things are held constant. The factors that are held constant include consumer income, tastes, expectations, prices of other goods, taxes and subsidies. These factors must remain constant because they will affect demand of a good besides the price effect.   

Figure 2

Supply Curve  

Supply curve is a graphical representation of the relationship between price and quantity supplied. The supply curve is shown in Figure 2. Notice that the supply curve is slopes upward to the right. The upward slope curve captures the law of supply which stated that the quantity supplied of a good or service is affected by the price of that good or service when other things remain constant. The law of supply states:

             Quantity supplied falls when price falls, other things remain constant.  

Quantity supplied rises when price rises, other things remain constant.

The law of supply is based on the firm’s ability to substitute its production of one good for another, or vice versa. When the price of a good rises, firms tend to supply more of that good to the market. The reason is the opportunity cost of not producing the good rises as its price rises. For instance, if the price of wheat rises and the price of corn remains the same, farmers sure will grow more wheat instead of corn, other things remain constant.    

Lastly, the other things that are held constant in supply include firm’s cost of production, technology level, expectations of future price movements, government taxes and subsidies. 

Figure 3

The Interaction of Demand and Supply Curves

Equilibrium

Figure 3 shows the equilibrium in an economy by combining both demand and supply curves together. In economics, equilibrium often refers to a situation when the upward pressure on price is exactly offset by the downward pressure on price. In other words, at the equilibrium price, quantity demanded must equals to the quantity supplied or the intersection point of demand and supply curves. Equilibrium quantity is the quantity of goods sold and bought at the equilibrium price. Equilibrium price is the price toward which the invisible hand drives the market. When equilibrium is achieved in economy, the allocation of goods and services is at its most efficient level since the quantity of goods being supplied is exactly same as the quantity of goods being demanded. This implies that every unit (countries, firms, and individuals) in an economy are satisfied with the current economic condition.     

Figure 4

Disequilibrium

Disequilibrium occurs in a country when the price (P) or quantity (Q) is not equal to the equilibrium price (P_e) or equilibrium quantity (Q_e). Disequilibrium happens either due to excess supply or demand of goods.

Excess Supply

Excess supply or surplus is a phenomenon when the quantity supplied is greater than quantity demanded in a market. As shown in Figure 4, when the price (P) is set too high or above the equilibrium price (P_e), some producers or suppliers in the market won’t be able to sell all their goods. For instance, at price P2, the quantity demanded by consumers is at Q₁, which is much lesser than quantity supplied by suppliers at Q₂. Since Q₂ is greater than Q₁, the goods in the market are over supplied or too much being produced and too little being consumed. As that happens, suppliers with excess goods will try to lower down their product’s price in order to create more demand. Thus, the price in the market will fall from P2 to P_e. Consumers will increase their consumption by buying more goods in the market when the price falls.  

Excess Demand

Similar with excess supply, excess demand in an economy will cause the disequilibrium. Excess demand or shortage is defined as a situation when the quantity demanded of a product is greater than quantity supplied of that product. Refer to Figure 5, shortage occurs when the price (P) is below the equilibrium price (P_e). For example, at price P1, the quantity of goods demanded by consumers is Q₂ but the quantity of goods supplied by producers is only at Q₁. Thus, there are more consumers who want the good than there are suppliers selling the same good. Since there are too little of goods in the market, consumers have to compete among themselves to buy the good at price P. The increase in demand will push the price upwards from P1 to P_e. Suppliers will be pleased and continue to supply more goods in the market. 

How to decide?

Every economic system faces the fundamental economic problems like what to produce, how to produce and for whom to produce. These problems are attributed by the scarcity. In other words, the available resources are limited but individuals’ wants and desires are unlimited.  

Opportunity Cost

Human wants are unlimited but the factors of production are limited. This leads to the problem of scarcity. Thus, a society must make a wise decision and choose what goods and services to produce. When the choice on what goods to produce is made, an opportunity cost is incurred. Opportunity cost of undertaking an activity is the benefit forgone by undertaking that activity. The benefit forgone is the benefit that one might have gained from choosing the next best alternative. In short, when society decided on what goods and services to produce, it’s also scarifying the production of other goods and services.

Figure 1: Production Possibility Curve and Opportunity Cost

Figure 1 presents the relationship between production possibility curve (PPC) and opportunity cost. PPC shows the maximum combination of outputs or final products that can be produced from a given number of inputs. Assume that Apple Inc. produce two type of products, iPhone and iPod. If Apple allocates all of the resources to produce iPhone (point a), then none of the iPod is produced. So, the opportunity cost to produce iPhone is to sacrifice the iPod’s production. Likewise, if Apple decided to produce iPod only (point b), the opportunity cost in this scenario is to give up the production lines that make iPhone. In point c, if Apple decided to produces both products in equal proportion, then the company must allocates part of the resources to produce iPhone and part of the resources to produce iPod. Overall, PPC slopes downward from left to right. The downward slope represents the concept of opportunity cost - you get more of one benefit only if you get less of another benefit. 

Determinants of Demand

Demand curve shows the relationship between price and quantity demanded. The determinants of demand are income, price of other goods, tastes and preferences, expectations about future prices and incomes, taxes and subsidies.

Determinants of Supply

Supply curve shows the relationship between price and quantity supplied. The determinants of supply are price of inputs, technology level, expectations, expectations, taxes and subsidies.

  

Price Elasticity of Supply and Demand

Figure 1: Elasticity of Demand

Elasticity is an important concept in economics. It is frequently used to describe the responsiveness of quantity demanded or supplied to price. Figure 1 shows the typical elasticity of demand curve. The price elasticity of demand (E_d) measures the percentage change in quantity demanded over the percentage change in price. The information derived from price elasticity of demand is very important because it tells us how quantity demanded responds to a change in price. For example, if the price elasticity of demand for iPhone 5 is 0.2, this implies that a 10% rise in iPhone 5 price will lead to a 2% fall in quantity demanded. Consumers shift their demand to other substitutable products which price are lower than iPhone like Samsung, Sony, HTC and so on. Thus, the larger the value of price elasticity, the larger the quantity responds to any price changes. As shown in Figure 1, there is various degree of price elasticity along the demand curve and the descriptions are listed below:

           

Figure 2: Elasticity of Supply

Figure 2 shows the elasticity of supply curve. The price elasticity of supply (E_s) measures the percentage change in quantity supplied over the percentage change in price. Similar to price elasticity of demand, the information derived from elasticity of supply is very informative since it measures how the quantity supplied responds to a change in price. For example, if the price elasticity of supply for iPhone 5 is 0.6, this implies that a 10% rise in iPhone 5 price will bring about 6% increase in quantity of iPhone 5 supplied. Overall, the larger the value of price elasticity of supply, the larger the quantity responds to any price changes. The descriptions on various degree of price elasticity along the supply curve are listed below:

Demand and Supply

Figure 1

Demand Curve

Demand curve is the graphical representation of the relationship between price and quantity demanded of a particular product or service.  Based on Figure 1, it is pretty clear that when price goes up, quantity demanded goes down and vice versa, other things remain constant. This shows that the price and quantity demanded are inversely related, as a result, demand curve is slopes downward to the right. This is consistent with the law of demand. The law of demand stated that:

                Quantity demanded falls when price rises, other things remain constant.

                Quantity demanded rises when price falls, other things remain constant.

The law of demand is fundamental to the invisible hand’s theory and shows its ability to coordinate individuals’ desires. For instance, as prices change, people tend to change their buying behaviors.

As mentioned above, economist have make an important assumption which is other things are held constant. The factors that are held constant include consumer income, tastes, expectations, prices of other goods, taxes and subsidies. These factors must remain constant because they will affect demand of a good besides the price effect.   

Figure 2

Supply Curve  

Supply curve is a graphical representation of the relationship between price and quantity supplied. The supply curve is shown in Figure 2. Notice that the supply curve is slopes upward to the right. The upward slope curve captures the law of supply which stated that the quantity supplied of a good or service is affected by the price of that good or service when other things remain constant. The law of supply states:

             Quantity supplied falls when price falls, other things remain constant.  

Quantity supplied rises when price rises, other things remain constant.

The law of supply is based on the firm’s ability to substitute its production of one good for another, or vice versa. When the price of a good rises, firms tend to supply more of that good to the market. The reason is the opportunity cost of not producing the good rises as its price rises. For instance, if the price of wheat rises and the price of corn remains the same, farmers sure will grow more wheat instead of corn, other things remain constant.    

Lastly, the other things that are held constant in supply include firm’s cost of production, technology level, expectations of future price movements, government taxes and subsidies. 

Figure 3

The Interaction of Demand and Supply Curves

Equilibrium

Figure 3 shows the equilibrium in an economy by combining both demand and supply curves together. In economics, equilibrium often refers to a situation when the upward pressure on price is exactly offset by the downward pressure on price. In other words, at the equilibrium price, quantity demanded must equals to the quantity supplied or the intersection point of demand and supply curves. Equilibrium quantity is the quantity of goods sold and bought at the equilibrium price. Equilibrium price is the price toward which the invisible hand drives the market. When equilibrium is achieved in economy, the allocation of goods and services is at its most efficient level since the quantity of goods being supplied is exactly same as the quantity of goods being demanded. This implies that every unit (countries, firms, and individuals) in an economy are satisfied with the current economic condition.     

Figure 4

Disequilibrium

Disequilibrium occurs in a country when the price (P) or quantity (Q) is not equal to the equilibrium price (P_e) or equilibrium quantity (Q_e). Disequilibrium happens either due to excess supply or demand of goods.

Excess Supply

Excess supply or surplus is a phenomenon when the quantity supplied is greater than quantity demanded in a market. As shown in Figure 4, when the price (P) is set too high or above the equilibrium price (P_e), some producers or suppliers in the market won’t be able to sell all their goods. For instance, at price P2, the quantity demanded by consumers is at Q₁, which is much lesser than quantity supplied by suppliers at Q₂. Since Q₂ is greater than Q₁, the goods in the market are over supplied or too much being produced and too little being consumed. As that happens, suppliers with excess goods will try to lower down their product’s price in order to create more demand. Thus, the price in the market will fall from P2 to P_e. Consumers will increase their consumption by buying more goods in the market when the price falls.  

Excess Demand

Similar with excess supply, excess demand in an economy will cause the disequilibrium. Excess demand or shortage is defined as a situation when the quantity demanded of a product is greater than quantity supplied of that product. Refer to Figure 5, shortage occurs when the price (P) is below the equilibrium price (P_e). For example, at price P1, the quantity of goods demanded by consumers is Q₂ but the quantity of goods supplied by producers is only at Q₁. Thus, there are more consumers who want the good than there are suppliers selling the same good. Since there are too little of goods in the market, consumers have to compete among themselves to buy the good at price P. The increase in demand will push the price upwards from P1 to P_e. Suppliers will be pleased and continue to supply more goods in the market. 

How to decide?

Every economic system faces the fundamental economic problems like what to produce, how to produce and for whom to produce. These problems are attributed by the scarcity. In other words, the available resources are limited but individuals’ wants and desires are unlimited.