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

"Opportunity cost is the cost of any activity measured in terms of the best alternative forgone" Wikipedia

1. Michelle would have forgone 0.25 chicken (50/200) to produce 1 potato.  

2. Michelle would have forgone 4 potatoes (200/50) to produce 1 chicken.

3. James would have forgone 0.50 chicken (40/80) to produce 1 potato.

4. James would have forgone 2 potatoes (80/40) to produce 1 chicken.

"In economics, principle of absolute advantage refers to the ability of a party (an individual, or firm, or country) to produce more of a good or service than competitors, using the same amount of resources." Wikipedia

5. Michelle is better at producing both goods, thus she has the absolute advantage.

"In economics, the law of comparative advantage says that two countries (or other kinds of parties, such as individuals or firms) can both gain from trade if, in the absence of trade, they have different relative costs for producing the same goods" Wikipedia

6. Michelle's relative cost for producing potatoes is 0.25 chicken, which is less than james relative cost of 0.50 chicken. Thus Michelle has the comparative advantage in potatoes

7. James relative cost for producing chickens is 2 potatoes, which is less than Michelle's relative cost of 4 potatoes. Thus James has the comparative advantage in chickens.

8. Yes they would both be better off trading. Michelle will specialize in the production of potatoes and trade with James because 2.5 pounds of potatoes for 1 chicken is much less than her opportunity cost of 16 pounds of potatoes for 1 chicken. James will then specialize in the production of chickens and trade with Michelle because 1 chicken for 2.5 pounds of potatoes is much less than his opportunity cost of 4 pounds of potatoes for 1 chicken.

9. James and Michelle will benefit from their trade but others in the socity as a whole or other nations may not. There may be other people in the society or other nations thats economy is completely dependent on the production of chickens for potatoes. If James and Michelle fill that demand, then others may parish because of it.   

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