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?
To determine the opportunity cost of producing a specific good, you need to compare the production capabilities of each individual and assess what they have to give up to produce an additional unit of that good.
1. Michelle's opportunity cost of producing potatoes:
Michelle can produce 200 pounds of potatoes per year or 50 chickens per year. To calculate the opportunity cost of producing potatoes, divide the number of chickens that Michelle would have to give up to produce one more pound of potatoes. In this case, it would be 50 chickens divided by 200 pounds, which equals 0.25 chickens per pound of potatoes. Therefore, Michelle's opportunity cost of producing potatoes is 0.25 chickens.
2. Michelle's opportunity cost of producing chickens:
To determine the opportunity cost of producing chickens, divide the number of pounds of potatoes that Michelle would have to give up to produce one more chicken. In this case, it would be 200 pounds of potatoes divided by 50 chickens, which equals 4 pounds of potatoes per chicken. Therefore, Michelle's opportunity cost of producing chickens is 4 pounds of potatoes.
3. James' opportunity cost of producing potatoes:
James can produce 80 pounds of potatoes per year or 40 chickens per year. To calculate the opportunity cost of producing potatoes, divide the number of chickens that James would have to give up to produce one more pound of potatoes. In this case, it would be 40 chickens divided by 80 pounds, which equals 0.5 chickens per pound of potatoes. Therefore, James' opportunity cost of producing potatoes is 0.5 chickens.
4. James' opportunity cost of producing chickens:
To determine the opportunity cost of producing chickens, divide the number of pounds of potatoes that James would have to give up to produce one more chicken. In this case, it would be 80 pounds of potatoes divided by 40 chickens, which equals 2 pounds of potatoes per chicken. Therefore, James' opportunity cost of producing chickens is 2 pounds of potatoes.
5. Absolute advantage:
Michelle has an absolute advantage in both potato production and chicken raising since she can produce more of each good than James. Michelle can produce 200 pounds of potatoes compared to James' 80 pounds, and she can raise 50 chickens compared to James' 40 chickens.
6. Comparative advantage in potatoes:
Michelle has a lower opportunity cost in producing potatoes (0.25 chickens per pound) compared to James' opportunity cost (0.5 chickens per pound). Therefore, Michelle has a comparative advantage in potato production.
7. Comparative advantage in chickens:
James has a lower opportunity cost in producing chickens (2 pounds of potatoes per chicken) compared to Michelle's opportunity cost (4 pounds of potatoes per chicken). Therefore, James has a comparative advantage in chicken production.
8. Trading at a rate of 2.5 pounds of potatoes for 1 chicken:
If they specialize completely in their areas of comparative advantage and trade at the specified rate, they would both benefit from trade. Michelle can produce potatoes more efficiently, so she would focus solely on potato production and trade her excess potatoes for James' chickens. James, on the other hand, would focus solely on chicken production and trade his excess chickens for Michelle's potatoes. This specialization and trade would allow them to consume a greater variety and quantity of goods, making both parties better off.