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 value priority waiter $30 per hour 3 clerk $50 per hour 1 sales $40 per hour 2

Opportunity cost =$40

Part-time waiter job value priority $30 per hour 3

clerk $50 per hour 1

Sales $40 per hour 2

steward $20 per hour 4

Opportunity cost =$40

Partwaiter time job value priority

clerk

sales

stewar d

tutor

$30 per $50 per $40 per $20 per $45 per hour hour hour hour hour 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 cost
The actual payments a firm makes to its factors of production and other suppliers.(2)

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

Part a
Economic surplus (trip to Paris ,do not use the frequentflyer 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.

Part c
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

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 governmentsubsidized 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 governmentsubsidized hospital = $10,000

Taking operation in private hospital

Benefit = $65,000 Opportunity Costs = $30,000

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

Taking operation in governmentsubsidized hospital

Benefit = $60,000 Opportunity Costs = $10,000

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

Part (a)

Economic surplus of taking operation in private hospital

= $35,000

Economic surplus of taking operation in governmentsubsidized hospital = $50,000

Part (a) answer

Albert should undertake operation government hospital.

in

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 governmentsubsidized 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
Benefit = $65,000

Opportunity cost
= $18,000

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 governmentsubsidized 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 governmentsubsidized hospital and make the claim to the insurance company

Benefit = $60,000 Opportunity cost= $9,000

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

Economic surplus of (i) = $47,000 Economic surplus of (ii) = $51,000

Economic surplus of (iii)

= $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 governmentsubsidized 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
Minimum economic surplus = $51,000
Benefit = $65,000 Opportunity cost = Y

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

Minimum economic surplus = $51,000 Benefit = $65,000

Opportunity cost = X/2 + $3,000 $51000 = $65000 - X/2 - $3000 X = $22,000

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

Problem Set Q2.1

Question 2.1(A)
20 July 2010

Stock

Close($)

Vol(1,000$)

HSBC
ICBC MTRC
21 July 2010

75.80
5.79 27.25

15,894
152,647 1,941

Stock
HSBC

Close($)
70.20

Vol(1,000$)
14,015

ICBC MTRC

5.74 27.35

187,611 1,784

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)

HSBC (21 July)

74.20
75.80

14,015
15,894

The price increases. And the volume transacted also increases.

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

The demand curve shifts to the right.

P1 P2

74.20 75.80

Q1 Q2

14,015 15,894
Increase in demand

Analysis of ICBC
Stock Close($) Vol(1,000$)

ICBC (20 July)

ICBC (21 July)

5.74
5.79

187,611
152,647

The price increases.

But the volume transacted decreases.

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

D
The supply curve shifts to the left.

P1 P2

5.74 5.79

Q1 Q2

187,611 152,647
Decrease in supply

Analysis of MTRC
Stock Close($) Vol(1,000$)

MTRC (20 July)

MTRC (21 July)

27.35
27.25

1,784
1,941

The price decreases.

But the volume transacted increases.

S1 The price decreased from P1 to P2 but the quantity transacted increased from Q1 to Q2. P2

D
The supply curve shifts to the right.

P1 P2

27.35 27.25

Q1 Q2

1,784 1,941
Increase in supply

Question 2.1(B)
20 July 2010

Stock ICBC
21 July 2010

Close($) 5.74

Vol(1,000$) 187,611

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

Stock ICBC

Close($) 5.74

Vol(1,000$) 152,647

Analysis of ICBC
Stock Close($) Vol(1,000$)

ICBC (20 July)

ICBC (21 July)

5.74
5.74

187,611
152,647

The price remains unchanged.

But the volume transacted decreases.

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

S2

S1

P Both the demand and supply curves shift to the left. D1 D2 Q

Q2

Q1

Decreased in both demand and supply

Question 2.1(C)
20 July 2010

Stock HSBC
21 July 2010

Close($) 74.20

Vol(1,000$) 14,015

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)

HSBC (21 July)

74.20
75.80

14,015
14,015

The price increases.

But the volume transacted remains unchanged.

S2

S1

As the quantity transacted remained unchanged but the price increased.

P2

P1
The demand curve shifts to the right while the supply curve shifts to the left. Q

D2
D1

Increase in demand decrease in supply

but

Reference

(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