Question 1: Define opportunity cost. What is the opportunity cost to you of attending college? What was your opportunity cost of coming to class?
Opportunity cost refers to the cost of a lost opportunity when one decides to forego it. Essentially, it denotes the benefit that one will lose from choosing one alternative over the other. The opportunity cost of attending college will be the income I would have earned from being formally employed or being an entrepreneur. The opportunity cost of coming to class is the fun that I would from going to a recreational park or a movie or participating in a lucrative competitive event.
Question 2: What are the arguments in favor of trade restrictions, and what are the counterarguments? According to most economists, do any of these arguments really justify trade restrictions? Explain.
Trade barriers have the merit of protecting local manufacturers and locally-produced goods from stiff competition from more established firms and goods. They are also important when dealing in equipment or materials relating to internal and external security of a country. Finally, imposing trade barriers prevents dumping of cheap and often low quality goods from foreign markets into the domestic one. On the other hand, trade barriers are disadvantageous because they decrease the range of choices that consumers have; give local manufacturers the opportunity to hike the price of goods and can result in low-quality goods. There is, however, no much justification for trade restrictions because the effects of globalization are being felt everywhere and countries are becoming more interdependent than before. Finally, the rise of the multinational corporation (MNC) has opened the global market to competition and the trend will continue.
Question 3: The Coase theorem suggests that efficient solutions to externalities can be determined through bargaining. Under what circumstances will private bargaining fail to produce a solution?
According to Coase the most effective solution to a property right dispute is possible only when there are no transactional costs or such costs are negligible. Coase asserts that when there are costs attached to the bargaining process, the bargaining parties may keep off the process. For example, if two parties are bargaining over property rights and it is required that they take care of the costs involved in holding discussion meetings like meals and so on, then the talks may not take place or may not be effective.
Question 4: What are opportunity costs? How do explicit and implicit costs relate to opportunity costs? Give a real world example of a firm and what its explicit and implicit costs may be.
Opportunity costs are incurred when one foregoes one alternative for another and can be classified into explicit and implicit costs. Implicit costs are those that represent the value of losing the alternative while explicit costs represent the value of the option that one has taken. For example a firm will incur explicit costs when it pays wages, electricity, and rent; buys machinery and raw materials and caters for other overheads. All these costs can be quantified and are related to a conscious choice by the firm to venture into production of a certain commodity or service. However, if the company has some unutilized potential, like a product it has not launched but has the ability to, then this is an implicit cost because it represents the value of the forgone. The calculation of implicit cost may not be as straightforward as that of the explicit one because it is not an activity that the firm has engaged in.
Question 5: List and describe the characteristics of a perfectly competitive market. Tell me if you believe the smart phone market meets these requirements and why or why not.
- Buyers and Sellers are Price takers
This market is only composed of price-takers thus implying that there is no bargaining and the buyers accept the set price without question.
- Products are homogenous
- Availability of perfect information
In a perfectly competitive market, buyers and sellers are perfectly aware of the current prices and the availability of commodities in the market at any one time.
- Freedom of entry and exit into the market
In this market, firms can introduce their products at will and exit freely depending on whether the venture is profitable or not.
The smart phone market does not meet these requirements primarily because smart phone prices are determined by demand, income levels, personal preferences and related factors and are not simply fixed by the market. Secondly, smart phones are not homogenous undifferentiated products because the market is flooded with products that have different features and specifications which keep on changing with changing client preferences. In addition, smart phone buyers do not have perfect information since different players introduce different products at different prices and times depending on market dynamics. Finally, the smart phone market is dominated by a few MNCs like Apple, Samsung, Nokia and Blackberry and thus has many costly entry barriers. Exit barriers may not be as stringent but still the firm has to cater for its loyal global clientele if it considers exiting.
Question 6: Explain the 3 types of price discrimination we discussed. Elaborate on how the firm segments customers and give an example of each.
- First degree discrimination: The seller in this case segments customers and sets the price according to the price that individual customers are willing to pay for a product. The seller must determine how much each of his customers is willing to pay for a product and then haggle based on that price. This strategy is applied especially in car sales and online sales where the seller may have personal information about the customer before the transaction.
- Second degree discrimination: In this category the seller sets the price and segments customers based on the number of units sold. Customers who buy more products get discounts and lower prices while those who buy less pay more. Retail outlets often use this strategy, popularly called ‘buy one get one free’ and so on.
- Third degree discrimination: The seller in this case sets the price based on segments created from special groups of people. The seller often targets special groups like youth, women, students or professionals in a certain field and so on. For example, a mobile phone company may come up with a special tariff for young people or a travel agency may give a special holiday travel offer to families or tourists.
