What is the law of increasing opportunity costs? Why do opportunity costs keep increasing?
One may define opportunity cost as the cost that a business incurs when it chooses to forego one production option in order to implement another competing option. From this, the law of increasing opportunity costs indicate that a decision by a business to increase its rate of production by one unit serves to increase the opportunity cost for producing the next additional unit. Opportunity costs normally keep increasing along the production possibility frontier. This is because producing an additional unit of product takes up some resources that would have efficiently been used to produce the next extra unit foregone. This perpetuates the increase in opportunity costs.
Suppose the U.S. Congress is considering passing an excise tax that would increase the price of a pack of cigarettes by $1.00. What would be the likely effect of this change on the demand and supply of cigarettes? What is likely to happen to cigarette prices and the quantity consumed if the tax bill is enacted?
Applying excise tax on cigarettes would increase the retailing price for cigarette packs. This would then lower the market demand for cigarettes, as the purchasing power of consumers would reduce. Holding other factors such as consumer income constant, the buyers would need to adjust their budgets and perhaps reduce their consumption of cigarettes to maintain their previous living standards. This would cut back on market demand. With lower market demand, the supply will also have to reduce, since most cigarette manufacturers would be making losses if they continue to produce larger quantities that match earlier market demand. The market surplus would only turn into losses for suppliers. Ultimately, the market would balance itself according to the law of demand and supply, resulting in less demand and less supply for the high market price occasioned by excise tax.
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