If when you buy a cup of coffee the highest valued

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Unformatted text preview: If, when you buy a cup of coffee, the highest-valued thing you forgo is some gum, then the opportunity cost of the coffee is the quantity of gum forgone. We can calculate the quantity of gum forgone from the money prices of the coffee and the gum. If the money price of coffee is $1 a cup and the money price of gum is 50¢ a pack, then the opportunity cost of one cup of coffee is two packs of gum. To calculate this opportunity cost, we divide the price of a cup of coffee by the price of a pack of gum and find the ratio of one price to the other. The ratio of one price to another is called a relative price, and a relative price is an opportunity cost. We can express the relative price of coffee in terms of gum or any other good. The normal way of expressing a relative price is in terms of a “basket” of all goods and services. To calculate this relative price, we divide the money price of a good by the money price of a “basket” of all goods (called a price index). The resulting relative price tells us the opportunity cost of the good in terms of how much of the “basket” we must give up to buy it. The demand and supply model that we are about to study determines relative prices, and the word “price” means relative price. When we predict that a price will fall, we do not mean that its money price will fall—although it might. We mean that its relative price will fall. That is, its price will fall relative to the average price of other goods and services. Review Quiz ◆ 1 2 3 What is the distinction between a money price and a relative price? Explain why a relative price is an opportunity cost. Think of examples of goods whose relative price has risen or fallen by a large amount. Work Study Plan 3.1 and get instant feedback. Let’s begin our study of demand and supply, starting with demand. 9160335_CH03_p053-080.qxd 6/22/09 8:56 AM Page 55 Demand ◆ Demand If you demand something, then you 1. Want it, 2. Can afford it, and 3. Plan to buy it. Wants are the unlimited desires or wishes that people...
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This note was uploaded on 04/04/2012 for the course ECON 251 taught by Professor Blanchard during the Spring '08 term at Purdue.

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