Kian and Rachel own a toy factory. Kian can build six toy ships per hour, earnin
ID: 1214476 • Letter: K
Question
Kian and Rachel own a toy factory. Kian can build six toy ships per hour, earning a total of $30. Rachel can build two toy ships in one hour, earning $10. Kian and Rachel’s friend Jeffrey asks if one of them would build a dollhouse for his daughter’s birthday. He would pay $100 for the job. It would take Kian four hours to build the dollhouse. It would take Rachel six hours to build the dollhouse. What is absolute advantage? What is comparative advantage? Who has the absolute advantage for building toy ships and why? Who has the absolute advantage for building the dollhouse and why? What is the opportunity cost for Kian if he accepted Jeffrey’s offer to build the dollhouse? What is the opportunity cost for Rachel if she accepted Jeffrey’s offer to build the dollhouse? Who has the comparative advantage for building the dollhouse? If the company were to start making dollhouses, how much should they charge? (Estimate or provide a range) How would you describe the gains in this trade, if there are any? Calculate the optimal balance of trade.
Explanation / Answer
Absolute advantage is the ability of an individual, firm or country to produce greater quantity of good by using same amount of resources.
A country, person, firm has comparative advantage in producing a good if opportunity cost of producing that good is lower in that country as compared to other country.
Kian has the absolute advantage in the production of toy ships because Kian is able to produce more units of toy ships as compared to Rachel in the same time.
Opportunity Cost: In four hours, Kian can either produce 1 unit of dollhouse or can produce 24 units of toy ships.
implies, 1 dollhouse = 24 toy ships
It means that to produce 1 dollhouse, Kian has to sacrifice 24 units of toy ships so opportunity cost of of building dollhouse is 24 units of toy ships.
Rachel Opportunity cost: 1 dollhouse = 12 toy ships ( 2 toy per hour X 6 hours spend on dollhouse)
So, opportunity cost of producing 1 dollhouse is 12 units of toy ships.
Rachel has comparative advantage in the production of dollhouse because she has to sacrifice less units of toy ships to produce dollhouse as compared to Kian.
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