Economics

Midterm Assignment
Submitted to: Madam Sadaf Alam
MBA 2 -3C (Evening)
Muhammad Umair 01-222191-013
Question # 1 (6 Marks)
Review the 2 articles related to any of the following concept s:

 Opportunity Cost
 Demand and supply
 Comparative Advantage
Article1: Opportunity cost neglect and consideration in the domain of time
Author Stephan A Spiller
Link:
Review
In our daily life every decision we take we have to incur an opportunity cost on it. Such accosts are
often neglected. They are only considered when user have constrained resources and also when
they know about alternatives. People necessarily consider opportunity cost in terms of money
rather than time domain as time is also a main factor in today’s busy world and time is also
considered important and it’s also said that time is money.
The opportunity cost of a chosen or selected item is the foregone benefit of the alternative option.
This paper highlights the opportunity cost generally and in time domain as well.
The factors that people consider while taking opportunity cost into accounts are
Memory: When people memorize all the options available they will consider them as an opportunity
cost factor while investing.
Resource Constraint: when the resources are limited people do consider alternative options and
consider opportunity costs.
Individual Differences: People who are good Planners, intelligent, positively associated with
economics will consider for opportunity cost.
Factors that people neglect and not consider opportunity costs are
Choices and Preferences: When people consider their choice as important factor and prefers a
certain good over another good they neglect opportunity cost.
Now let’s apply time factor on opportunity cost. As we all know that time flies and can never be
back its non-occurrence enhances the consideration for opportunity cost. People who considers
time and think time value will hugely considers it as an important factor while making any decision.
They are well aware of what they are letting go to achieve something that is most important for
them. They do prioritize their tasks and then make a tradeoff between them. When someone have
a choice to spend now or to spend in future they do consider opportunity cost and perceived
resources of then and now to be more realistic.
When People tend to choose an option from a lot of options they have to bear some cost of letting
go the other best option. Ehen People neglect other options and are exposing them to risk they
might not like to but when people are resource constrained they tend to consider opportunity cost
more.
Time has important part to play in opportunity cost as well and has become an important factor for
consideration of opportunity cost as well. People in the past might only consider letting go off
monetary opportunity cost but now opportunity cost with respect to time has become important.
Because time has no alternative and people are time constrained these days they have to consider
time as an important factor. When there is a choice to be made either to invest today or later
(opportunity cost over time) future opportunity costs are often underweighted. As we know that
future expenses have less weight than future income when we use to access available resources
that reduce the importance of future opportunity cost.
Article2: Opportunity cost in Buying and Short selling Do they really matter?
Author Tal Shavit et al
Link:
Review
This paper Reveal the information about opportunity cost consideration in People’s buying and
selling behavior. It says that people do not consider opportunity cost in buying or opportunity profit
while selling. Opportunity cost is defined as the unrealized utility from choice of different
alternatives and studies have showed that people give very less importance and mealy consider
opportunity cost in their daily life routine.
This paper also tells how people take opportunity cost and opportunity profits into consideration
during auctions. Study was conducted as an experiment in a business class where researcher
visited class for an experiment purpose where he distributed some money to the students.
Researcher distributed 40 NIS (Israeli shekels) to each student and asked them to utilize this
money in the experiment and make decisions.
A questionnaire was distributed offering six different listed second Price auctions for lottery ticket.
In first three options subjects were asked to bid prices for buying position and next three they were
asked prices for short selling position for same lotteries in buying position. Details are described in
below mentioned table.

Position Asset (probability) Alternative

Buy option 1 30 or 10 Nis (50,50) Get 10 NIS
Buy option 2 30 or 10 Nis (50,50) Get 0
receive fix amount if not win
Buy option 3 20 or 0 Nis (50,50) Get 0
Sell option 1 -30 or -10 Nis (50,50) Pay 10 NIS
Sell option 2 -30 or -10 Nis (50,50) Pay 0
Pay fix amount if not win
Sell option 3 -20 or 0 Nis (50,50) Pay 0

It was found that in buying position only 31.3 percent of participants bid for higher prices for lottery
without the alternative similarly 45 percent asked for higher prices without alternatives. Participants
were also informed that if they did not win the auction they have to either to receive (buying) or pay
(selling) fixed sum of amount. Participants did not considered this while taking their decisions.
Secondly Participants did not noticed that bid buy option 1 was equivalent of buy option 2. Similarly
sell option 1 with the alternative to pay 10 NIS for losing auction and 3 were same as in each.
In short they checked that the bid/ask price of the lottery with alternative ticket was same of the
bid/ask price of no alternative lottery.
Results suggested that opportunity cost and profit are important to be considered in any financial
decision and people ignore both while taking financial decision. The results states that people
actually over price risky assets.
Short selling is done by investors to enhance more equity. Alternative Leverage costs associated
with the risk free rate was not considered by investors as well.

Question # 2 (4 Marks)
Identify the factors those can affect the elasticity of the goods. Take example of any 6
goods and apply on them the factors those can have an influence on them.
Elasticity of demand is always different for different goods i.e. a change in Price does not lead to
same Proportionate change in demand of different goods e.g. a small change in price of an LED
TV may affect its demand to a certain extent while a small change in price of an Shampoo may not
affect its demand.
Formula to calculate Price Elasticity of demand
Price elasticity of demand= Change in Quantity demanded/ Change in Price

Price elasticity of Demand calculated Type of elasticity

=∞ Perfectly Elastic
=0 Perfectly Inelastic
=1 Unit elastic
<1 In Elastic
>1 Elastic

Factors that influence Price Elasticity of Demand are as below with more than six examples of
goods:
1. Availability of Substitutes
As close as the substitute of the good is available, more the elastic its demand would be. The
reason is that if there is a small rise in a good’s Price consumer will opt or go for a substitute
product. On the other side goods haves no or less substitutes will have inelastic demand.

Availability of Substitutes Examples Price Elasticity of Demand

Yes Tea/Coffee Elastic
No Salt In Elastic

2. Related Goods
If a Product is tied or related to other product and have dependency on each other and because of
dependency the demand will remain inelastic. However a good which is standalone and has
independent of other goods will have elastic demand.

Related Goods Examples Price Elasticity of Demand

Independent Salt,Buiscuits Elastic
 Dependent Tea/Milk In Elastic

3. Income Level
For a high level of income demand of a good would be inelastic because rich people will not be
affected as much because of the change in price as compared to poor people so if income level is
low demand would be elastic as poor people are highly affected by the change in price of the good.

Level of Income Examples Price Elasticity of Demand

Lower income group Refrigerator Elastic
Higher income group Refrigerator In Elastic

4. Level/Range of Price
Range of Price can also be an important factor. A good that has a high range of price and is very
costly will have an elastic demand as its demand will depend on range of price. However a less
costly product will have an inelastic demand as change in price will not affect the demand of good
by notable amount.

Price Range Examples Price Elasticity of Demand

Costly Diamond Elastic
In Expensive Pencil In Elastic

5. Time Period
For a longer period of time the demand will be elastic of a good and for a shorter period of time the
demand of good will be inelastic. This is because it is difficult for consumer to change their need or
habits in short period of time as compared with in long period of time.

Time Period Examples Price Elasticity of Demand

Long time House Elastic
Short time Medicine In Elastic

6. Proportion of consumer Income Spent

As the proportion of Income spent is Greater on a good, the demand for it would be more elastic.
Similarly any good that takes a less portion of one’s income will have an inelastic demand. This is
because one barely notice the higher price of a good whose proportion of expenditure is less.

Proportion of Consumer Examples Price Elasticity of Demand

Income
More Car Elastic
Less Salt In Elastic

7. Number of uses
A good that has several uses its demand will be elastic. When the price of such good is increase it
is put for the use of most important and necessary purposes first as its demands falls and similarly
when the price falls it can be used for less urgent needs as well. A commodity that has few uses
will have an inelastic demand.

Number of uses Examples Price Elasticity of Demand

Many Milk Elastic
Few Pencil In Elastic

8. Nature of Commodity
Nature of commodity can be necessity or a luxury item. For a necessity good like, food, cloths etc.
the demand will be inelastic as they are basic requirements and their demand does not fluctuate as
their price changes and for a luxury good demand will be elastic.as consumer can postpone the
use of good.

Availability of Substitutes Examples Price Elasticity of Demand

Luxury Car Elastic
Necessity Clothes In Elastic

9. Postponement of Consumption
Commodities whose consumption is immediately required are considered to be inelastic as they
cannot be postponed and those commodities whose demand is not that urgent and can be
postponed would have an elastic demand as they are sensitive to change in price.

Postponement of Examples Price Elasticity of Demand

Consumption
Delayed Biscuits, Soft drinks Elastic
Immediately Medicine In Elastic

10. Habits
Those goods which have become habits of a consumer will have inelastic demand and those
which are not habits will be having elastic demand. When a commodity becomes a habit of a
consumer regardless of a price hike he or she will buy that good.

Habits Examples Price Elasticity of Demand

Yes Cigarette In Elastic
No Movie Ticket Elastic
Question # 3 (5 Marks)
Take the example of any project of a company or at macroeconomic level and identify the
following costs: FC, VC and TC. Also identify why the shape of MC curve is like tick mark
and why the shapes of variable cost curves are U shaped?
Fixed Cost
Fixed cost is the cost with a company is going to incur regardless of how much a company
produce. It remains constant even the company’s sales/Production volume is changed or not. e.g.
 Rent of office
 Depreciation
 Interest Expense
 Amortization
 Utility
 Salaries
 Insurance
Variable Cost
Variable cost is the cost which is directly related to the sales/Production volume of the business or
unit produced. As the production volume increases or decreases a company its variable cost
changes respectively.
e.g.
 Direct Materials
 Piece rate Labor/Direct Labor
 Commissions
 Delivery /Shipping
 Advertisement
VC=Cost per unit* total units produced
Total Cost
Total cost is the cost of Production which includes all the fixed cost plus variable cost.
TC=FC+VC
Now let us take an example to understand better and identify all these costs.
Cost Information of J and K Electronics
They Produce 400 units Per Month

Fixed Cost Per unit Amount in rupees Variable cost Per unit Amount in rupees
 Office Rent 88000 Direct Material 411
Equipment Depreciation 27000 Direct Labor 300
Utility 76400 Commission 250
Salaries 120000 Advertisement 100
Admin Expense 62000 Shipping Charges 200

By using above data Cost calculations are done as below

Fixed Cost and Variable cost Calculations

Total Fixed cost 373400 Variable cost per unit 1261

Per unit fixed cost 933.5 Total Variable cost 504400

Total cost calculations:

Total Cost Per unit (Rs) 933.5+1261=2194.5

Total Cost (Rs) 373400+504400=877800

Equation
Y=c+mx
Y is the Total cost , C is the Fixed cost , m is the units Produced, x is variable cost.
Tc=FC+(Q)VC
Tc=933.5+1261*(400)
As we noticed from the equation that by producing one more unit an increase of 1261 rs is
occurring in in total cost.
Graphical Representation
Total cost
Shape Identification of MC Curve
Marginal cost curve is often depicted like a round tick shape Marginal cost curve is drawn with the
quantity on horizontal axis and measurement of cost on vertical axis.
Initially when any organization starts its production quantity that it produces is quite low as
marginal curve is decreasing in the start it means each additional unit is cheaper to produce from
previous one so that is the reason that slope is going downwards. After some point we see that
marginal cost of each additional unit tends to rise or we can say more expensive than last product
this is the time when marginal curve starts increasing and positively sloped.
The decreasing Trend in the short run is because of firm inputs which are Capital and Labor. It
means that the quantity this firm is producing is dependent on Capital and labor considering short
run an important thing. As we know that organization’s capital is fixed and if it wants to produce
more quantity they surely have to increase the number of labors to get more quantity produced as
capital is fixed. A question arises that how adding more labors will help the organization to be more
cost efficient answer lies in this that by hiring more labors will help firm to specialize in areas and
organization will be producing more units this increase in efficiency will allow organization to make
cheaper Products one after another so that why marginal cost decreases. After some time as
organizations capital is fixed they will face resources constrained it becomes very tough to
increase production by only just increasing the number of labors now what happens is since all the
capital is utilized our extra labor might have to wait for long hours and their resource utilization
might not remain as effective as organization have limited resources like machinery etc. so
because of capacity constrained as capital level is fixed additional units tends to be more
expensive and expensive and marginal cost of unit produced will increase after one another. So
increasing the number of labor is a failure without increasing capital and machinery.
Shape identification of Variable Cost Curves
Variable cost curve is often depicted like a U shape drawn with the quantity on horizontal axis and
measurement of cost on vertical axis.
There are 3 phases of Variable Cost curves
 Initial Marginal Return
 Constant Return
 Diminishing Marginal Return
At IMR as we tend to Produce more quantity in the initial stage we use economies of scale by
using mass production, we have skilled and efficient labor working on special tasks and also the
usage of resources are optimal. Initially division of labor and work are also aligned and economies
of scale can be achieved and variable cost is also increased so initially average cost slope tends to
slope downward as it adds to value.
Then there comes Constant return a point which is minimum efficient scale. This is the lowest point
in the U shape it is also known as profit optimizing output. Profit maximizing output is the point
where we have maximum profit. The quantity we are producing at this point is providing us
maximum profit.
Third and last Phase is DMR at this point due to diseconomy of production and law of diminishing
returns total variable cost increases.at this point additional cost increases because additional
quantity produced will not add any value so the slope starts pointing upward.