Q.
a) Explain the statement "demand is a function of price". (5 marks)
b) Explain the concept of opportunity cost with reference to the production possibility curve. (15 marks)
(20 marks, 2013 Q2)
A.
a) In economics, an 'inverse demand function', P = f−1(Q),is a function that maps the quantity of output demanded to the market price (dependent variable) for that output.
Quantity demanded, Q, is a function of price; the inverse demand function treats price as a function of quantity demanded, and is also called the price function.
[1]
Note that the inverse demand function is not the reciprocal of the demand function—the word "inverse" refers to the mathematical concept of an inverse function.
Ref:
Wikipedia search 'demand is a function of price' at
http://en.wikipedia.org/wiki/Inverse_demand_function
b) Opportunity cost has been posted earlier here. However, its relationship with production possibility cost is specifically discussed below.
There are four elements working in action within the production possibilities curve. They are:-
1. The element of scarcity.
2. The law of increasing opportunity costs.
3. The economy is inefficient, hence producing within the curve.
4. Economic growth, and innovation, hence able to produce outside the curve.
Below is a typical production possibility curve, illustrating the various points for easier explanation.
To illustrate increasing opportunity cost as an element in production possibility curve, the example below is used.
Increasing opportunity cost simply means it is going to cost more eventually to swift the production from one item to the other. In the above example, when the sample nation is making only Radio and no TV (point A), the cost to sacrifice Radio in place for TV
(point A to B) is 15 Radios for 25 TVs, ie one Radio for 1.67 TV
(Point B to C) is 20 Radios for 15 TVs. ie one Radio for 0.75 TV
(Point D to E) is 35 Radios for 20 TVs. ie one Radio for 0.57 TV
Hence, the cost is on an increase. The more you want anything, the more you have to forgo something else. In the above case, the more TVs you want, the more Radios you have to give up.
[Thus, to choose to produce item A instead of item B, the opportunity cost of losing item B is getting greater as the production possibility curve gets to produce more A. It becomes harder and harder to produce item A as the resources (skilled labour, raw materials, etc) eventually get harder and harder to find. As letting go the opportunity to produce item B, more and more opportunity to produce item B is slipping away between the fingers. Why? Take the example of the Radio and TV production possibility curve above, lesser TVs are produced at the expense of letting go producing Radio. In other words, the same opportunity if given to produce Radio, would produce more Radio, instead being 'wasted' in producing TVs.]
Ref:
See earlier posts.
[x] own account.
