shadow prices

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    syed ali
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    i have confusion in the shadow price concept as in notes shadow price is the extra price pay for extra unit of limited resource but it is calculated as difference between old contribution and new contribution i have confusion in this please help me


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    John Moffat
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    If a resource is limiting the production, then if you had more of the resource you could produce more and therefore make a bigger total contribution.

    So…..it is worth buying more of the limited resource provided the extra cost of it is less than the extra total contribution that you would generate.

    If you watch my lecture on this chapter then it might help you make sense of it.


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    syed ali
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    i think that that the difference between the old and new contribution is shadow price and this difference is the cost of extra unit of limited resource which we use for generating extra contribution is i am right


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    John Moffat
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    Almost :-)

    The shadow price is defined as the most extra you would be prepared to pay for one extra unit of a limited resource.

    The way we calculate it is to calculate the extra contribution that we would make if we did have one extra unit of the limited resource.

    So……for example, suppose we are paying labour at the rate of $5 per hour, but we are using all the labour available. To get more labour we would need to pay more than $5 per hour. But how much more would we be prepared to pay?

    If the shadow price of labour is (for example) $3 per hour, then the most we would be prepared to pay to get more labour would be $8 per hour (5 + 3). If we could get more labour at a lower cost than $8 then great – we can make more money. If it costs more than $8 then there would be no point in us buying the extra hours.

    If you want to see calculations of the figures then watch my lecture.

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