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Chan Yeung Chuen

Yeung Tse Fung

Problem Set Q1.1

Question

“According to the definition of opportunity cost, the more alternatives that we have given up in the undertaking an action, the higher the opportunity cost.” Please make a critical comment on this statement and explain your answers using examples.

Opportunity cost

The opportunity cost of any choice (the next-best alternative) is what we forgo when we make that choice.

Opportunity cost cannot be infinity

Part time job

Part-time job

waiter clerk sales

value $30 per hour

$50 per hour

$40 per hour

priority 3 1 2

Opportunity cost =$40

Part-time job

waiter clerk Sales steward

value $30 per hour

$50 per hour

$40 per hour

$20 per hour

priority 3 1 2 4

Opportunity cost =$40

Part-time job

waiter clerk sales steward

tutor

value $30 per hour

$50 per hour

$40 per hour

$20 per hour

$45 per hour

priority 4 1 3 5 2

Opportunity cost =$45

Definition – wrong

But possible!

Problem Set Q1.2

Suppose you are considering whether to go to Paris with a group of classmates during your summer

holidays. The round trip airfare from Hong Kong to Paris is $6,000, but you can select to pay this airfare with a frequent-flyer coupon. All other

relevant costs for the vacation in Paris are $10,000. The most you would be willing to pay for the Paris vacation is $19,000. This amount is your benefit of taking the vacation in Paris. Your only alternative use for your frequent-flyer coupon is your trip to

New York after summer holidays and this is a trip that you must make. The Hong Kong-New York

round-trip airfare is $8,000.

Part a

What is the economic surplus of your trip to Paris if you do not use the frequent-flyer coupon for the trip? Explain your answer and show your calculation.

Economic surplus

The economic surplus from taking any action is the benefit of taking that action minus its cost. (1)

=benefit – (explicit cost + implicit cost)

Benefit=The most I would like to pay for the trip

Explicit costThe actual payments a firm makes to its factors of production and other suppliers.(2)

Implicit costsThe opportunity costs of the resources supplied by the firm's owners. (3)

Part a

Economic surplus (trip to Paris ,do not use the frequent-flyer coupon)

=benefit – (explicit cost + implicit cost)

=19000-(6000+10000)=3000

Part b

What is the economic surplus of your trip to Paris if you use the frequent-flyer coupon for the trip ? Explain your answer and show your calculation.

Part b

Economic surplus (trip to Paris ,use the frequent-flyer coupon) The benefit for trip to Paris = 19000 The explicit cost for the trip = 0 The implicit cost for the trip = 10000 + 8000

benefit – (explicit cost + implicit cost)

= 19000 – (0 + 10000+8000)

=1000

Part c

Should you use the frequent-flyer coupon for the trip to Paris or use it for the trip to New York ?

The cost-benefit principle:

An individual (or a firm or a society) should take an action if, and only if, the extra benefits from taking the action are at least as great as the extra costs.

Economic surplus (trip to Paris ,do not use the frequent-flyer coupon)

=19000-(6000+10000)= 3000

V.S

Economic surplus (trip to Paris , use the frequent-flyer coupon) = 19000 – (0 + 10000+8000)= 1000

Part c

Conclusion

Frequent-flyer coupon should be used for the trip to New York.

Problem Set Q.1.3

Background Albert make all his decisions based on

economic rationale and his sole objective is to maximize his economic surplus. He is required to undertake a minor surgical operation and he can select to have it done in the private hospital or in the government-subsidized hospital. He is willing to pay a maximum of $65,000 for having the operation done in the private hospital and $60,000 for having the operation done in the government-subsidized hospital. The fee charged by the private hospital equals $30,000 and the fee charged by the government-subsidized hospital equals $10,000.

Part (a) question

Explain whether Albert should undertake the operation in the private hospital or in the government-subsidized hospital.

Cost-Benefit principle

An individual (or a firm or a society) should take an action if, and only if, the extra benefits from taking the action are at least as great as the extra costs.

Economic surplus : The economic surplus from taking

any action is the benefit of taking that action minus its cost.

Economic surplus equation = Benefit – Opportunity Costs

Part (a)

What is the maximum price Albert willing to pay for having the operation done in private hospital and government-subsidized hospital?

Part (a)

Maximum price of taking operation in private hospital

= $65,000

Maximum price of taking operation in government-subsidized hospital

= $60,000

Benefit of taking operation in private hospital

= Maximum price of taking operation in the private hospital

= $65,000

Benefit of taking operation in government-subsidized hospital

= Maximum price of taking operation in government-subsidized hospital

= $60,000

Part (a)

What is the opportunity costs taking operation in private hospital and government-subsidized hospital?

Opportunity costs= the fee charged by the hospital

• Opportunity costs of taking operation in private hospital

= the fee charged by the private hospital

= $30,000

• Opportunity Costs of taking operation in government-subsidized hospital

= the fee charged by the government-subsidized hospital

= $10,000

Taking operation in private hospital

Economic surplus = $65,000 – $30,000 = $35,000

Taking operation in government-subsidized hospital

Economic surplus = $60,000 – $10,000= $50,000

Part (a)

Part (a) answer

Albert should undertake operation in government hospital.

Reason: Economic surplus of taking operation in

government-subsidized hospital ($35,000)

> Economic surplus of taking operation in private hospital ($50,000)

Additional background Now suppose Albert has purchased a health

insurance policy and paid three months ago. The increase policy entitles Albert to claim 50% of any expense incurred in a private hospital and 40% of any expense incurred in the government-subsidized hospital. However, the annual premium for the next year will be increased by $3,000 if he has made a claim in the current year. Albert has already decided that he will definitely continue to purchase the insurance policy for the next year.

Part (b) Question

Explain whether Albert should (i) undertake his operation in private

hospital and make the claim to the insurance company

(ii) undertake his operation in government-subsidized hospital and make the claim to the insurance company

(iii) maintain its decision as in the answer (a) (undertake his operation in government-subsidized hospital) and not make any claim to the insurance company

(i) undertake his operation in private hospital and make the claim to the insurance company

Opportunity Costs= 50% of the fee + annual premium for

the next year will be increased = $30,000 x 50% + $3,000= $18,000

(i) Undertake his operation in private hospital and make the claim to the insurance company

Economic surplus= $65,000 – $18,000= $47,000

Failure to ignore sunk cost

Sunk cost:- Costs incurred in the past- Cost cannot be recovered at the

moment a decision is made- irrelevant to decision of whether to

take the action

(ii) undertake his operation in government- subsidized hospital and make the claim to the insurance company

Opportunity cost

= 60% of the fee + annual premium for the next year will be increased

= $10,000 x 60% + $3,000

= $9,000

(ii) Undertake his operation in government-subsidized hospital and make the claim to the insurance company

Economic surplus= $65,000 – $9,000= $51,000

(iii) maintain its decision as in the answer (a) (undertake his operation in government-subsidized hospital) and not make any claim to the insurance company

Economic surplus = $50,000

Part (b) answer

Albert should undertake his operation in government-subsidized hospital and make the claim to the insurance company.

Reason: Highest economic surplus of (i)

($51,000)

Part (c) question

Suppose all the above information is known to the manager of the private hospital. Calculate the maximum fee that he can change Albert for having Albert agreeing to undertake the operation in his hospital.

From Part (b): The highest economic surplus (undertake his operation in

government-subsidized hospital and make the claim to the insurance company)

= $51,000

Two ways

1) take operation in private hospital and do not claim for it

2) take operation in private hospital and claim for it

1) take operation in private hospital and do not claim for it

Let Y be the maximum fee charged by private hospital

51000 = 65000 - Y Y = $14,000

2) take operation in private hospital and claim for it

Let X be the maximum fee charged by private hospital

$51000 = $65000 - X/2 - $3000 X = $22,000

Maximum fee charged of (1)= $14,000Maximum fee charged of (2)= $22,000

Maximum fee charged= $22,000

Problem Set Q2.1

Question 2.1(A)

Stock Close($) Vol(1,000$)

HSBC 70.20 14,015

ICBC 5.74 187,611

MTRC 27.35 1,784

20 July 2010Stock Close($) Vol(1,000$)

HSBC 75.80 15,894

ICBC 5.79 152,647

MTRC 27.25 1,941

21 July 2010

State whether each stock has experienced a decrease in demand, increase in demand, decrease in supply or increase in supply, assuming there were changes in either the demand or supply curves but not both.

From the table,

•The closing price of each stock can be known as the aggregated market equilibrium price (EP)

•The volume of each stock can be known as the aggregated market equilibrium quantity (EQ)

Analysis of HSBC

Stock Close($) Vol(1,000$)

HSBC (20 July) 74.20 14,015

HSBC (21 July) 75.80 15,894

• The price increases.

• And the volume transacted also increases.

P1 74.20 Q1 14,015

P2 75.80 Q2 15,894

The price increased from P1 to P2 while the quantity transacted increased from Q1 to Q2.

P

The demand curve shifts to the right.

Increase in demand

Analysis of ICBC

Stock Close($) Vol(1,000$)

ICBC (20 July) 5.74 187,611

ICBC (21 July) 5.79 152,647

• The price increases.

• But the volume transacted decreases.

P1

5.74 Q1 187,611

P2

5.79 Q2 152,647

The price increased from P1 to P2 but the quantity transacted decreased from Q1 to Q2.

D

P1

P

The supply curve shifts to the left.

Decrease in supply

Analysis of MTRC

Stock Close($)

Vol(1,000$)

MTRC (20 July)

27.35 1,784

MTRC (21 July)

27.25 1,941

• The price decreases.

• But the volume transacted increases.

P1 27.35 Q1 1,784

P2 27.25 Q2 1,941

The price decreased from P1 to P2 but the quantity transacted increased from Q1 to Q2.

S1

P2

D

The supply curve shifts to the right.

Increase in supply

Question 2.1(B)

Stock Close($)

Vol(1,000$)

ICBC 5.74 187,611

20 July 2010

21 July 2010

Explain how you conclude about the shifts of its demand and supply curves between 20 and 21 July 2010.

Stock Close($)

Vol(1,000$)

ICBC 5.74 152,647

Analysis of ICBC

Stock Close($)

Vol(1,000$)

ICBC (20 July)

5.74 187,611

ICBC (21 July)

5.74 152,647

• The price remains unchanged.

• But the volume transacted decreases.

P

Q

D1

S1S2

D2

P

Q1Q2

As the price remained the same but the quantity transacted decreased from Q1 to Q2.

Both the demand and supply curves shift to the left.

Decreased in both demand and supply

Question 2.1(C)

Stock Close($)

Vol(1,000$)

HSBC 74.20 14,015

20 July 2010

21 July 2010

Explain how you conclude about the shifts of its demand and supply curves between 20 and 21 July 2010.Stock Close($

)Vol(1,000$)

HSBC 75.80 14,015

Analysis of HSBC

Stock Close($)

Vol(1,000$)

HSBC (20 July)

74.20 14,015

HSBC (21 July)

75.80 14,015

• The price increases.

• But the volume transacted remains unchanged.

P

QD1

S1S2

D2

P1

Q

As the quantity transacted remained unchanged but the price increased.

P2

The demand curve shifts to the right while the supply curve shifts to the left.

Increase in demand but decrease in supply

(1) Frank, Robert H., and Bernanke, Ben S., Principles of Economics, Fourth edition, McGraw Hill, 2009, 6

(2) & (3) Frank, Robert H., and Bernanke, Ben S., Principles of Economics, Fourth edition, McGraw Hill, 2009, 204

Reference

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