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.
What is Michelle's opportunity cost of producing potatoes? very good, becauce she raises 200 pounds per year and 50 chickens per year.
which one would have a comparative advantage if they specialize in producing 2.5 lbs of potatoes to one chicken
To answer these questions, we need to understand the concept of opportunity cost and comparative advantage.
Opportunity cost is the value of the next best alternative that must be forgone in order to produce or consume something. It measures the trade-off involved in making a choice.
Comparative advantage is the ability of an individual, business, or country to produce a good or service at a lower opportunity cost compared to others. It is determined by comparing the opportunity costs of different activities.
Now let's apply these concepts to the given scenario:
1. Michelle's opportunity cost of producing potatoes:
To determine this, we compare the number of chickens she could produce if she allocated all her resources to raising chickens. Michelle can produce 50 chickens if she devotes all her resources to it, so her opportunity cost of producing potatoes is 50 chickens.
2. Michelle's opportunity cost of producing chickens:
Similarly, we compare the amount of potatoes Michelle could produce if she allocated all her resources to growing potatoes. Michelle can produce 200 pounds of potatoes if she focuses on them, so her opportunity cost of producing chickens is 200 pounds of potatoes.
3. James' opportunity cost of producing potatoes:
James can produce 40 chickens if he devotes all his resources to raising them. Therefore, his opportunity cost of producing potatoes is 40 chickens.
4. James' opportunity cost of producing chickens:
James can produce 80 pounds of potatoes if he concentrates solely on growing them. Hence, his opportunity cost of producing chickens is 80 pounds of potatoes.
5. Absolute advantage:
Michelle has an absolute advantage in both potato production and chicken raising as she can produce more of both compared to James.
6. Comparative advantage:
To determine comparative advantage, we compare the opportunity costs. Michelle has a lower opportunity cost of producing potatoes compared to chickens (200 pounds vs. 50 chickens), while James has a lower opportunity cost of producing chickens compared to potatoes (40 chickens vs. 80 pounds). Therefore, Michelle has a comparative advantage in potato production, and James has a comparative advantage in chicken raising.
7. Specialization and trade:
Since Michelle has a comparative advantage in producing potatoes and James has a comparative advantage in producing chickens, it would be beneficial for each of them to specialize in their respective areas of comparative advantage. After specializing, they can engage in trade.
In this case, if they trade at a rate of 2.5 pounds of potatoes for 1 chicken, they would both be better off. Michelle can produce potatoes at a lower opportunity cost of 200 pounds of potatoes for 50 chickens, which implies her cost is 4 pounds of potatoes per chicken. James, on the other hand, can produce chickens at a cost of 40 chickens for 80 pounds of potatoes, which is 2 pounds of potatoes per chicken. Therefore, when they trade at a rate of 2.5 pounds of potatoes for 1 chicken, both Michelle and James can gain from the exchange.
8. Extension to businesses, society, or nations:
The concept of comparative advantage applies not only to individuals but also to businesses, society, and nations. In a broader context, businesses or countries can specialize in production based on their comparative advantage and then engage in international trade.
By specializing in areas where they have a comparative advantage, businesses can increase efficiency, reduce costs, and maximize productivity. This can lead to higher economic growth and increased welfare for society as a whole. Similarly, nations can benefit from international trade by focusing on industries where they have a comparative advantage and exchanging goods and services with other countries. This leads to a more efficient allocation of resources, increased specialization, and overall economic development.