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.

To determine opportunity cost, we need to compare the output of one activity to the output of another activity. Opportunity cost is the value of the next best alternative that is forgone. In this scenario, Michelle produces 200 pounds of potatoes if she devotes all her resources to growing potatoes, and 50 chickens if she devotes all her resources to raising chickens. Similarly, James produces 80 pounds of potatoes and 40 chickens.

Michelle's opportunity cost of producing potatoes is the number of chickens she could have produced instead. Since Michelle can produce 50 chickens, her opportunity cost of producing potatoes is 50 chickens.

Michelle's opportunity cost of producing chickens is the number of potatoes she could have produced instead. Since Michelle can produce 200 pounds of potatoes, her opportunity cost of producing chickens is 200 pounds of potatoes.

James' opportunity cost of producing potatoes is the number of chickens he could have produced instead. Since James can produce 40 chickens, his opportunity cost of producing potatoes is 40 chickens.

James' opportunity cost of producing chickens is the number of potatoes he could have produced instead. Since James can produce 80 pounds of potatoes, his opportunity cost of producing chickens is 80 pounds of potatoes.

Absolute advantage refers to the ability to produce more of a good or service compared to another person. In this case, Michelle has an absolute advantage in both potato production and chicken production because she can produce more of each compared to James.

Comparative advantage, however, refers to the ability to produce a good or service at a lower opportunity cost. To determine comparative advantage, we need to compare opportunity costs.

Michelle's opportunity cost of producing potatoes (50 chickens) is lower than James' opportunity cost of producing potatoes (40 chickens). Therefore, Michelle has a comparative advantage in potato production.

Michelle's opportunity cost of producing chickens (200 pounds of potatoes) is higher than James' opportunity cost of producing chickens (80 pounds of potatoes). Therefore, James has a comparative advantage in chicken production.

If they specialize in their comparative advantages, Michelle will produce only potatoes and James will produce only chickens. Assuming they trade at a rate of 2.5 pounds of potatoes for 1 chicken, they can then trade their products.

Michelle, with her comparative advantage in potatoes, would trade some of her potatoes for James' chickens. Both Michelle and James would benefit from this trade because Michelle can use her resources more efficiently to produce potatoes, and James can do the same for chickens. This trade allows them to consume a greater variety of goods (both potatoes and chickens) compared to if they didn't specialize and trade.

Extending this scenario to businesses, society as a whole, or nations, the concept of comparative advantage and specialization plays a crucial role. By specializing in the activities where they have a comparative advantage, businesses, society, or nations can maximize their efficiency and productivity. This can lead to increased overall output, economic growth, and improved standards of living. Trade allows for the exchange of goods and services that are produced most efficiently, leading to mutual benefits and broader choices for all parties involved.