Suppose that two people, Mary and John each live alone in an isolated region. They each have the same resources available, and they grow corn and raise pigs. If Mary devotes all her resources to growing corn, she can raise 200 pounds of corn per year. If she devotes all her resources to raising pigs, she can raise 50 pigs per year. (If she apportions some resources to each, then she can produce any linear combination of pigs and corn that lies between those extreme points. If John devotes all his resources to growing corn, he can raise 80 pounds of corn per year. If he devotes all his resources to raising pigs, he can raise 40 pigs per year. (If he apportions some resources to each, then he can produce any linear combination of pigs and corn that lies between those extreme points.)
Corn
Pigs
Mary
200
50
John
80
40
What is Mary’s opportunity cost of producing corn?
What is Mary’s opportunity cost of producing pigs?
What is John’ opportunity cost of producing corn?
What is John’ opportunity cost of producing pigs?
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 corn 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.
Use your text. I'm in your class by the way.
Use your text. I'm in your class by the way. Liliana Montoya!
whatever thing a person has to give up to have something else is the opportunity cost.
Mary gave up 50 pigs to get corn so the opp cost is 50 pigs
To determine opportunity cost, we need to compare the trade-offs each person faces when choosing to produce one good over another. Opportunity cost measures the value of the next best alternative forgone when making a decision.
Mary's opportunity cost of producing corn is the number of pigs she could have produced instead. Since Mary can raise 50 pigs per year if she devotes all her resources to pigs, her opportunity cost of producing corn is 50 pigs.
Mary's opportunity cost of producing pigs is the amount of corn she could have produced instead. Mary can raise 200 pounds of corn per year if she devotes all her resources to corn, so her opportunity cost of producing pigs is 200 pounds of corn.
John's opportunity cost of producing corn is the number of pigs he could have produced instead. John can raise 40 pigs per year if he devotes all his resources to pigs, so his opportunity cost of producing corn is 40 pigs.
John's opportunity cost of producing pigs is the amount of corn he could have produced instead. John can raise 80 pounds of corn per year if he devotes all his resources to corn, so his opportunity cost of producing pigs is 80 pounds of corn.
Mary has an absolute advantage in both corn and pigs because she can produce more of both goods than John.
To determine comparative advantage, we compare the opportunity costs of producing goods between individuals. Mary has a lower opportunity cost of producing corn than John (50 pigs compared to 80 pounds of corn), while John has a lower opportunity cost of producing pigs than Mary (40 pigs compared to 200 pounds of corn).
If Mary specializes in corn production and John specializes in pig production, they can benefit from trading with each other. Since Mary's opportunity cost of producing corn is 50 pigs and John's opportunity cost of producing pigs is 40 pounds of corn, they can agree on a trade ratio of 1 pound of corn for 2.5 pigs. By specializing and trading, Mary can obtain more pigs than she could produce herself, and John can obtain more corn than he could produce himself, making them both better off.
When extending these concepts to businesses, society as a whole, or nations, the principle of comparative advantage applies. Each entity should specialize in producing goods or services in which they have a lower opportunity cost, and then engage in trade with other entities to maximize overall output and efficiency. This allows entities to allocate resources more efficiently and access goods and services outside their own production possibilities. Specialization and trade can lead to increased overall productivity and economic growth.