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 comparative advantage in potatoes?
•Which person has comparative advantage in chicken?
•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

Potatoes Chickens Michelle 200 50 James 80 40 •What is Michelle’s opportunity cost of producing potatoes? 50/200=1/4 For each potato, Michelle must give up one fourth of a chicken. •What is Michelle’s opportunity cost of producing chickens? 200/50 = 4 For each chicken, Michelle must give up four chickens. •What is James’ opportunity cost of producing potatoes? 40/80 = 1/2 For each potato, James must give up half a chicken. •What is James’ opportunity cost of producing chickens? 80/40 = 2 For each chicken, James must give up 2 potatoes. •Which person has an absolute advantage in which activities? Michelle has an absolute advantage in producing potatoes and chickens because she could produce more of potatoes or chickens on her own if she devoted all of her resources to one or the other. •Which person has comparative advantage in potatoes? Michelle has a comparative advantage in potatoes because her opportunity cost for a potato is lower than James' opportunity cost for a potato. •Which person has comparative advantage in chicken? James has a comparative advantage in chickens because his opportunity cost for a chicken is less than Michelle's opportunity cost for a chicken. •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. James will specialize in chickens and Michelle will specialize in potatoes. James will benefit from a price of 2.5 pounds of potatoes for 1 chicken because his opportunity cost of a chicken is only 2 potatoes. Michelle will also benefit because her opportunity cost of a chicken is 4 potatoes. James will gain 0.5 potatoes per sale of a chicken while Michelle will gain 1.5 potatoes per purchase of a chicken. Here, I am measuring producer and consumer surplus in terms of potatoes, but we could easily do the same in terms of chickens. •How would you extend the above narrative to businesses, society as a whole or nations? Explain. Some businesses may have an absolute advantage in producing multiple products. In fact, some small companies may not have an absolute advantage in producing any product. But each company can find a comparative advantage at producing something. And when they produce that product and trade, everyone will benefit.

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