POE — Principles of Economics

Marginal choice and the relevant alternative

Choose the next unit of an activity by comparing its additional benefit with its additional opportunity cost. The relevant alternative is the best feasible alternative forgone, not the sum of every rejected option. A historic expenditure that cannot be recovered is sunk. An avoidable future expense is relevant. Separate accounting entries from economic resource use before recommending a lending, branch or investment decision. A positive economic profit depends on the stated alternatives and risk assumptions; it is not proof that the decision is legally or prudentially acceptable.

Reading a production possibility frontier

An inward move from the frontier can indicate unemployment or inefficient resource use. A move along the frontier reallocates resources and involves opportunity cost. An outward shift represents changed productive capacity, for example through technology or skills. A bowed-out frontier illustrates rising opportunity cost when resources are imperfect substitutes. State which axis measures which output and distinguish a feasible point from a desirable allocation: efficiency alone does not settle distribution or social priorities.

A bank can use a specialist team for project A yielding BDT 1.2 million or project B yielding BDT 0.9 million. It chooses A. What is the opportunity cost?

The opportunity cost is the BDT 0.9 million benefit from the best feasible alternative B, assuming the benefits are comparable and the team cannot serve both. It is not 1.2 million and not the sum of all rejected proposals. Risk, timing and other constraints would need separate assessment.

A completed feasibility study cost BDT 100,000 and cannot be resold. Should the bank count it as an additional cost when deciding whether to proceed?

No. The unrecoverable past study cost is sunk. Compare the future incremental benefits with avoidable future costs and opportunity costs. The study may still provide useful information; excluding its historic cost does not mean ignoring its findings.

Midpoint elasticity and total expenditure

Use percentage change in quantity divided by percentage change in price. The midpoint convention uses the average of the two quantities and the average of the two prices, so reversing the direction does not change the absolute elasticity. Demand elasticity usually has a negative sign; many textbooks discuss its absolute magnitude. Along an elastic demand segment, a price rise reduces total expenditure, other things equal. This is a local comparison: a price change can move the buyer to a segment with a different elasticity.

Credit demand, shifts and incidence

A change in the price of credit is a movement along a specified demand curve. Changes in expected investment returns, borrower income or uncertainty can shift credit demand. A higher funding cost can shift loan supply. When both curves move, the effect on quantity may be ambiguous even if the direction of the interest-rate effect is clear. A tax or fee is economically borne according to relative responsiveness, not simply by the party legally required to remit it. Draw and label the curves before discussing incidence.

Price rises from BDT 100 to BDT 120 and quantity demanded falls from 100 to 80. Calculate midpoint price elasticity and compare total expenditure.

Average quantity = 90; quantity change = -20, or -22.2222%. Average price = 110; price change = 20, or 18.1818%. Elasticity = -1.2222 (absolute value 1.2222, elastic). Expenditure falls from 100 x 100 = BDT 10,000 to 120 x 80 = BDT 9,600. The calculation describes the assumed two points, not a universal demand relationship.

A drought reduces crop supply while household demand rises. Can you predict the direction of both equilibrium price and quantity?

Both shifts raise equilibrium price in the usual model. The supply reduction lowers quantity while the demand increase raises it, so the net quantity change depends on the relative shift sizes. A confident quantity prediction without those sizes is unsupported.

Average cost, marginal cost and a short-run shutdown

Average fixed cost falls as a fixed cost is spread over more output. Marginal cost measures the change in total cost from an additional unit; use compatible output increments. In a competitive short-run model, a firm may operate despite an accounting loss if revenue covers variable costs and contributes to unavoidable fixed costs. A price below minimum average variable cost supports shutdown under the model. Long-run exit differs because costs that were fixed can become avoidable. Do not use this classroom rule to override a borrower liquidity or solvency assessment.

Productivity and scale are different questions

Diminishing marginal returns asks what happens when one input rises while at least one other input stays fixed. Returns to scale asks what happens when all inputs rise proportionately. Economies of scale concern long-run average cost and may arise from specialization or indivisible equipment. Capacity expansion does not guarantee cost savings: coordination, management and financing costs can offset them. State the time horizon and input assumptions before naming the concept.

A firm has fixed cost BDT 50,000 and variable cost BDT 80,000 for 1,000 units. Price is BDT 100. Would immediate shutdown improve its short-run result if fixed cost is unavoidable?

Revenue is BDT 100,000. Operating loss = 100,000 - 80,000 - 50,000 = BDT -30,000. Shutdown loss is the unavoidable fixed cost of BDT 50,000. Operating contributes BDT 20,000 to fixed cost and is preferable under these assumptions. Reassess if fixed costs are avoidable, alternative uses exist or additional risks are omitted.

Total cost rises from BDT 200,000 at 500 units to BDT 212,000 at 550 units. Find incremental cost per unit.

Change in cost = BDT 12,000; change in output = 50 units. Average incremental cost over this interval is BDT 240 per unit. It approximates marginal cost for the interval; it is not total cost divided by final output.

Profit, competition and entry

Marginal revenue equals marginal cost is a candidate interior optimum, subject to the relevant cost and demand conditions. For a price-taking firm, marginal revenue equals price. A monopolist facing downward-sloping demand generally has marginal revenue below price. Short-run economic profit can attract entry where barriers are low, reducing profits over time. Zero economic profit means normal opportunity costs are covered; it does not mean no accounting profit or no payments to owners.

Assessing banking competition

Use product-market boundaries rather than counting banks alone. Retail deposits, SME loans, remittances and specialist trade services may face different competitors. Switching costs, information advantages, brand trust and network access can limit substitution. Consider entry barriers and regulation as well as market concentration. A high market share is a fact to investigate, not sufficient evidence of abuse. Explain both cost advantages and customer risks before suggesting an intervention.

A competitive firm sells an additional unit for BDT 500 and incurs marginal cost BDT 450. What does marginal analysis suggest?

The additional unit adds BDT 50 before other omitted incremental costs. Expansion is worthwhile at this point under the price-taking model. It does not follow that unlimited expansion is profitable: marginal cost may rise and capacity or financing constraints may bind.

Why can a banking market with many branches still have limited competition?

Branches may belong to a few institutions. Customers can face switching costs, uneven information and limited substitutes for specialized services. Define the product and geographic market, inspect ownership/concentration and compare service quality and pricing. Branch count alone cannot establish a competitive market structure.

Information failures and lending

Adverse selection arises before contracting when the lender cannot reliably distinguish borrower risk. A uniform high rate may discourage safer applicants and worsen the applicant pool. Moral hazard arises after contracting when actions or incentives change, such as using proceeds for a riskier project. Screening, borrower equity, covenants and monitoring address different parts of the problem and involve costs. Collateral does not eliminate the need to assess repayment capacity, enforceability and asset value.

Externalities and intervention trade-offs

A private decision can impose costs or benefits on others without compensating them. A corrective tax aims to align private and social marginal costs, but measurement and enforcement are difficult. Public goods are non-rival and non-excludable in the model; a good supplied by government is not automatically a public good. Financial stability measures can reduce spillovers while also altering incentives. Compare benefits, implementation costs, distribution and unintended effects rather than assuming intervention always improves welfare.

A borrower conceals a risky business model before a loan and later diverts funds to speculation. Identify the two information problems.

Concealment of pre-existing risk before contracting is adverse selection. Changing the use of funds after contracting is moral hazard. Initial due diligence targets the first; enforceable covenants, disbursement controls and ongoing monitoring target the second. Both can coexist.

Does a higher government subsidy always correct a market failure?

No. Establish the failure and the mechanism first. A subsidy can encourage beneficial activity, but it may be poorly targeted, fiscally costly, captured by producers or encourage excessive risk. Compare the proposed instrument with disclosure, regulation, a tax or doing nothing under the stated evidence.

National income and inflation arithmetic

Nominal GDP values output at current prices; real GDP removes the selected price change under the stated base. GDP deflator = nominal GDP / real GDP x 100. A higher nominal value can reflect prices, output or both. Inflation is the percentage change in a price index, not the level of prices. Disinflation means inflation slows while prices may still rise. For interest comparisons, exact real interest = (1 + nominal rate) / (1 + inflation rate) - 1. The simple subtraction is an approximation.

Policy transmission and external accounts

A policy-rate change can affect market rates, borrower cash flows, asset values, exchange rates and expectations. Transmission depends on bank balance sheets, competition, liquidity and confidence. Fiscal stimulus can raise demand, but financing, imports and capacity constraints affect the result. In a simple closed-economy multiplier exercise with no taxes or imports, the spending multiplier is 1/(1 - MPC); do not transfer it mechanically to Bangladesh. The balance of payments records transactions with nonresidents; a current-account deficit is not the same concept as a government budget deficit.

Nominal GDP is 132 and the GDP deflator is 110, with base 100. Find real GDP.

Real GDP = 132 / 110 x 100 = 120 in the stated base-period units. No currency unit or growth rate can be inferred without further information.

A deposit pays 12% nominal interest while inflation is 8%. Calculate the exact real return and compare the approximation.

Exact real return = 1.12 / 1.08 - 1 = 0.037037, or approximately 3.70%. The approximation is 12% - 8% = 4%. State whether rates cover the same period and whether taxes/fees are excluded.

Interpreting Bangladesh indicators without inventing current figures

An examination answer should distinguish an indicator definition from its latest observation. For Bangladesh, identify the producing agency, period, unit, coverage and any revision. Compare stock measures, such as a reserve balance at a date, with stock measures; compare flows, such as remittances over a month, with comparable flows. A year-on-year increase and a month-on-month decrease can both be true. Describe possible drivers as hypotheses until supported by evidence. These notes do not supply live inflation, exchange-rate or reserve statistics.

Exchange-rate quotations and borrower exposure

For a quotation in BDT per USD, a higher number means more taka are required to buy one dollar. The percentage increase in that quotation is not numerically identical to the percentage fall in the reciprocal value of the taka. An importer with dollar payments and taka income can face a higher taka liability after depreciation, while an exporter may gain taka receipts but also pay more for imported inputs. Contract timing, hedging, price pass-through and actual cash flows determine the net effect. Avoid assuming every exporter benefits or every borrower has the same exposure.

In a hypothetical exercise the exchange rate moves from BDT 100/USD to BDT 110/USD. What happens to an unhedged USD 50,000 import payment?

The taka payment rises from 50,000 x 100 = BDT 5,000,000 to 50,000 x 110 = BDT 5,500,000, an increase of BDT 500,000 or 10%. The taka value measured in USD falls from 1/100 to 1/110, approximately 9.09%. These are hypothetical exercise rates, not current market quotations.

Remittances rise year-on-year but foreign-exchange reserves fall during the same month. Is that necessarily contradictory?

No. Remittances are one flow in a wider external and financial system; reserves are a stock affected by other receipts, payments, valuation changes and transactions. Verify periods, definitions and reserve measures before attributing the change. The two observations alone do not establish a causal explanation.