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Costs Evaluation and Business Decision Making

Comparative Advantage

Comparative Advantage Simulation Results
Figure 1.1. Comparative Advantage Simulation Results

This simulation illustrates how an individual considers all options available and their consequences, demonstrating how opportunity costs are evaluated to make informed business decisions. In particular, the opportunity’s value needs to be assessed on the basis of benefits and costs associated. Furthermore, a comparative advantage simulation implies the cost-efficiency and ability to produce a unit at a lower opportunity cost. The benefits of comparative advantage for a company include higher profitability, stronger sales margins, and lower prices compared to competitors.

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An essential microeconomic concept used in the decision-making process is a production-possibility frontier (PPF). A PPF is a graph representing scarcity and trade-offs by showing different combinations of output that can be produced given the resources, materials, capacity, and technology available (Reinert, 2020). In other words, this tool visualizes the possibilities and effects of each economic choice and provides a basis for better-informed decisions.

Comparative advantage impacts a company’s decision to engage in trade by allowing them to make the trade-off worth it. The theory of comparative advantage implies that international trade gains result from the pursuit of comparative advantage and the production of goods and services at a lower opportunity cost (Reinert, 2020). This critical principle of economics can be applied by countries, companies, and individuals. Firms with different comparative advantages engage in mutually beneficial trade (Reinert, 2020). For instance, when each partner focuses on producing the good with the lowest opportunity cost, restrictions are released, and time is utilized efficiently.

A business’s decision to trade can cause a change to its PPF and extend it. Namely, a company can consume at points outside the production-possibility frontier when comparative advantage is maximized (Reinert, 2020). For example, while a firm is not engaged in trade, it consumes at the point of the PPF. In contrast, specialization allows to change the constraints and produce at the lower opportunity cost benefiting both companies involved in the trade.

Competitive Markets and Externalities

Competitive Markets Simulation Results
Figure 2.1. Competitive Markets Simulation Results

As a rule, the free forces of demand and supply determine market outcomes. However, policy interventions may be required for some goods to facilitate or restrict the market for a particular product, resulting in a change in the supply and demand equilibrium for a product (Reinert, 2020). Different interventions can be imposed on a good or service, including a price floor, a price ceiling, and a tax. For instance, based on the competitive markets simulation results, a price ceiling below the marketplace can cause a shortage of goods.

The determinants of price elasticity of demand include the availability of substitutes, the share of income, the timeframe, and the good’s category, such as a necessity or a luxury. Based on the simulation outcome, it can be seen that price elasticity can impact pricing decisions and the total revenue of the firm. In particular, if the demand is inelastic, the product’s price and the total revenue increase (Reinert, 2020). In contrast, elastic demand causes prices to change and total revenue to remain the same (Reinert, 2020). Hence, companies can evaluate whether the total income will grow or decrease using the price elasticity of demand.

Based on the simulation results, it is unlikely that policy market interventions can cause a change in consumer or producer surplus. When a tax is posed on businesses by the government, most firms raise their prices, resulting in a decreased demand. Generally, when consumers observe an increase in prices due to tax, they either decide not to purchase the good or accept the price but are unwilling to offer more than the asking price.

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Reinert, K. A. (2020). An introduction to international economics: New perspectives on the world economy (2nd ed.). Cambridge University Press.

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