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

Michelle produces 200 potatoes with the same amount of resources as she can produce 50 chickens. So to produce 200 potatoes, she gives up producing 50 chickens. This means she gives up 1/4 of a chicken for every potato. This is her opportunity cost of producing potatoes. (1/4 of a chicken) To produce 1 chicken, she must give up producing 4 potatoes. This is her opportunity cost of producing chickens (4 potatoes) James produces 80 potatoes with the same amount of resources as he uses to produce 40 chickens So to produce 80 potatoes, he gives up producing 40 chickens. This means he gives up 1/2 of a chicken for every potato he produces. This is his opportunity cost of producing potatoes (1/2 of a chicken) To produce 1 chicken, he must give up producing 2 potatoes. This is his opportunity cost of producing chickens (2 potatoes) Michelle produces 200 chickens while James produces only 80 with the same resources. She has an absolute advantage in producing chickens. Likewise, Michelle produces 50 potatoes with the same amount of resources that it takes James to produce only 40. She has an absolute advantage in producing potatoes too. Michelle gives up producing 1/4 of a chicken to produce a potato, while James must give up producing 1/2 of a chicken to produce a potato (their opportunity cost). Michelle has the comparative advantage in producing potatoes. Michelle must give up producing 4 potatoes to produce 1 chicken, while James only gives up producing 2 potatoes to produce 1 chicken. James therefore has the comparative advantage in producing chickens. If Michelle only produces potatoes, and James produces only chickens and the trade at a rate of 2.5 pounds of potatoes for 1 chicken, Then Michelle is better off since she is receiving 1 chicken at the cost of 2.5 potatoes (whereas to produce it on her own, she would have to give up 4). James is also better off since he is receiving 2.5 potatoes at the cost of 1 chicken, where would only get 2 potatoes at the cost of producing 1 chicken on his own. This extends to businesses, societies and nations since some nations (businesses/societies) may have an absolute advantage in producing many goods or services, but others may have a comparative advantage in the production of some of these. Both are made better off by specializing where they have a comparative advantage and trading those goods with other countries for goods that the other country (again or business/society) has the comparative advantage in producing.

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