Suppose two people, Michelle and James each live alone in an isolated region. Bo

Question

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



1. What is Michelle's opportunity cost of producing potatoes?

2. What is Michelle's opportunity cost of producing chickens?

3. What is James' opportunity cost of producing potatoes?

4. What is James' opportunity cost of producing chickens?

5. Which person has an absolute advantage in which activities?

6.Which person has comparative advantage in potatoes?

7. Which person has comparative advantage in chickens?

8. Suppose that they are thinking of each specializing completely in the area in which they have a comparative advantage, and then at a rate of 2.5 pounds of potatoes for 1 chicken,would they each be better off?

Explain

9. How would you extend the above narrative to businesses, society as a whole or nations? Explain

Explanation / Answer

in the absence of a currency, the opportunity cost of anything is the thing given up. since the problem specifies that the production curves are linear, if follows that Michelle's opportunity cost of producing potatoes is 50/200 = 1 chicken per 4 pounds of spuds. you do the rest of these -- absolute advantage means greatest output per year if they do only that one thing -- you can answer this. comparative advantage means gives up the least to get one unit of the specified good. -- you can do this, too. *** [next to last] ... any exchange rate in between the production ratios of the two participants would leave them both better off. since the production ratios are 4 to 1 and 2 to 1, the answer for 2.5 to 1 is 'yes'. you prove this by demonstrating that, if James trades half his year's output of chickens [20] to Michelle, that he will have more than he could get by devoting half his energy to both, and the same for Michelle if she accepted the same trade. *** as it happens, specialization of labor in exactly this fashion between people, families, neighborhoods, cities, regions, states, and nations is the cause of about 1/2 of all productivity gains in the entire economy. [employment of capital goods causes the other half.] {productivity gains means the excess of total output over the amount you would expect given the quantity of labor available.} the more sophisticated question which our politicians refuse to discuss is why, when there is slack in the labor force [a cohort of unemployed people], they do not relax interfering policies which prevent the unemployed from producing anything at all [whatever they are good at would be of some value, instead of receiving no output at all from the unemployed]. listing all of the things 'interfering policies' might be is left as an exercise for the student.

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