Suppose that two people, Michelle and James each live alone in an isolated regio

Question

Suppose that two people, Michelle and James each live alone in an isolated region. They each have the same resources available, and they grow potatoes and raise chickens. If Michelle devotes all her resources to growing potatoes, she can raise 200 pounds of potatoes per year. If she devotes all her resources to raising chickens, she can raise 50 chickens per year. (If she apportions some resources to each, then she can produce any linear combination of chickens and potatoes that lies between those extreme points. If James devotes all his resources to growing potatoes, he can raise 80 pounds of potatoes per year. If he devotes all his resources to raising chickens, he can raise 40 chickens per year. (If he apportions some resources to each, then he can produce any linear combination of chickens and potatoes that lies between those extreme points.)

Potatoes Chickens
Michelle 200 50
James 80 40

• What is Michelle’s opportunity cost of producing potatoes?
• What is Michelle’s opportunity cost of producing chickens?
• What is James’ opportunity cost of producing potatoes?
• What is James’ opportunity cost of producing chickens?
• Which person has an absolute advantage in which activities?
• Which person has a comparative?
• Suppose that they are thinking of each specializing completely in the area in which they have a comparative advantage, and then trading at a rate of 2.5 pounds of potatoes for 1 chicken, would they each be better off? Explain.
• How would you extend the above narrative to businesses, society as a whole or nations? Explain.

Explanation / Answer

Opportunity cost is how many of good X you have to give up to get 1 of good Y. For Michelle she can grow 200 potatoes or 50 chickens so her opportunity cost for chickens is 200/50= 4 potatoes per chicken and the reciprocal of that(1/4) for Potatoes. James can produce 80 potatoes or 40 chickens. His OC of chickens is 80/40= 2 potatoes/chicken and for potatoes, it is 1/2. Absolute advantage is which person, company, group, etc can produce more of a good per worker, day, person, etc. In this case there are only 2 people involved, so it is simply which one can produce more on the PPF. Michelle therefore has the absolute advantage in both. Comparative advantage is whichever person has a lower opportunity cost in the good. By definition, no person can have a comparative advantagein all goods. in this case, James has a comparative advantage in Potatoes and Michelle has a comparative advantage in potatoes. Trade benefits a person if th trade cost is less than their cost if they are buying and if it is more than their cost if they are selling. Since James would be producing the chickens and selling to Michelle, That price would benefit both because it is greater than James's opportunity cost and Less than Michelle's. You can expand the narrative to any other scenario by replacing person names with company names and changing the types of goods, the overall ideas are the same.

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