Economics: Opportunity Cost and Market Dynamics

Opportunity Cost

• Choosing one option means giving up another
• Explicit cost: monetary sacrifice
• Implicit cost: non-monetary sacrifice, like time
• The opportunity cost of a choice is the value of the best alternative forgone
• Opportunity cost influences the optimal decision

Market Dynamics

• People respond to changes in costs and benefits
• Increased benefits and decreased costs encourage action
• Examples include plastic bag charges and EV incentives

Supply and Demand Model

• Shows how prices are determined in a market economy
• Explains how prices allocate scarce resources
• The "law of demand" states: as prices rise, quantity demanded falls; and as prices fall, quantity demanded rises

Demand

• Quantity demanded: the amount buyers are willing and able to purchase
• Demand: the relationship between price and quantity demanded
• Demand curve: a graph showing the relationship between price and quantity demanded
• Individual demand: the maximum amount an individual is willing to pay for a product

Negative Externalities

• Occur when market transactions impose costs on third parties not involved in the exchange
• Market equilibrium, where supply and demand meet, is higher than the socially optimal quantity
• Solutions include imposing taxes on sellers to internalize the externality

Externalities and Market Inefficiency

• Negative externalities result in a market quantity larger than socially desirable
• Positive externalities result in a market quantity smaller than socially desirable
• Internalizing the externality, for example through taxes or subsidies, can correct the inefficiency

Public Policy Toward Externalities

• Command-and-control policies regulate behaviour directly, like pollution limits and technology requirements
• Market-based policies provide incentives for private solutions, such as corrective taxes and subsidies

Corrective Taxes and Subsidies

• Corrective taxes are designed to internalize the social costs of negative externalities
• Called Pigouvian taxes after English economist Arthur Pigou
• Ideal corrective tax equals the external cost
• Corrective subsidies are used for activities generating positive externalities

Private Solutions to Externalities

• Coase theorem: When parties can bargain without cost over resource allocation, they can solve externality problems themselves
• Examples: tradable permit systems for sustainable use of resources and carbon taxes

Common Resources and Government Role

• Policies to prevent overconsumption include:
  • Privatization of the resource, making it excludable
  • Regulating usage, like Beijing's license plate policy
  • Imposing corrective taxes, like hunting licenses
  • Auctioning permits, like electromagnetic frequency spectrum, to define property rights and enable market forces

Natural Resource Curse

• Mineral resources can lead to resource curse when their abundance doesn't translate to economic prosperity
• Countries with abundant resources may experience slower economic growth, weak governance, and social inequality
• Strategies to mitigate the resource curse include:
  • Investing in human capital, diversification of the economy, and fostering good governance
  • Avoiding dependence on resource rents and ensuring that resource revenues are used responsibly
  • Investing in infrastructure and technological development to facilitate economic diversification

Test your knowledge on opportunity cost, market dynamics, and the supply and demand model. This quiz covers key economic concepts, including the impacts of explicit and implicit costs and the law of demand. Enhance your understanding of how prices and demand interact in a market economy.